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UNIVERSITY  OF  CALIFORNIA 
AT  LOS  ANGELES 


VALUE 

FOR 

RATE-MAKING 


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VALUE 

FOR 

RATE-MAKING 


BY 
HENRY  FLOY,  A.  B.,  M.  A.,  M.  E. 

CONSULTING    ENGINEER,    FELLOW     AMERICAN    INSTITUTE    OF    ELECTRICAL    ENGINEERS, 
MEMBER   AMERICAN    INSTITUTE  OF  CONSULTING  ENGINEERS,  AMERICAN  SOCIETY 
OF   CIVIL  ENGINEERS,  AMERICAN   GAS  INSTITUTE,    ILLUMINATING   ENGI- 
NEERING  SOCIETY,  AMERICAN  WATER  WORKS  ASSOCIATION,  NEW 
YORK  ELECTRICAL  SOCIETY,    AUTHOR    OF    "VALUATION 
OF       PUBLIC        UTILITY       PROPERTIES,"        "THE 
COLORADO      SPRINGS      LIGHTING      CON- 
TROVERSY,"   "high    tension, 
UNDERGROUND       ELEC- 
TRIC CABLES,"  ETC. 


First  Edition 
Second  Impression 


McGRAW-HILL  BOOK  COMPANY,  Inc. 
NEW  YORK:  370  SEVENTH  AVENUE 

LONDON:  6  &  8  BOUVERIE  ST.,  E.  C.  4 
191  G 


Copyright.  1916,  hy  the 
McGraw-Hill  Book  Company,  Inc. 


PRINTED   IN   THE    UNITED  STATES    OF   AMERICA 


THt  MAPLE  PRESS  -  YORK  PA 


T-  6  6  v^ 


PREFACE 

At  the  present  time,  probably  the  majority  of  vahiations  of 
pubhc  utiHty  property  are  being  made  in  connection  with  a  con- 
sideration of  rates.  But  different  authorities  still  hold  various 
and  conflicting  views  as  to  the  principles  involved  in  determining 

X      the  basis  of  value  for  rate-making. 

i        With  the  hope  of  helping  define  methods  used  and  standard- 

0    izing  practice  in  valuation  procedure,  the  author  ])rought  out,  four 

^    years  ago,  the  first  book  that  had  appeared  relating  to  the  general 

subject,  "The  Valuation  of  Public  Utility  Properties."     Since 

that  time,  several  other  books  have  been  published,  many  papers 

written  and  much  discussion  elicited,  due  to  the  development  of 

. .  a  rapidly  increasing  general  interest  in  the  subject  of  valuation 
of  utility  properties,  for  the  purposes  of  purchase  or  sale,  rate- 
making,  taxation  or  capitalization.  Despite  this  activity,  it  is  a 
disappointment  to  observe  that  terms  are  still  used  inexactly 
and  opinions  are  almost  as  diverse  and  numerous  as  there  are 
writers. 

The  purpose  of  this  book  is  an  attempt  to  further  emphasize 
at  least  three  principles  that  seem  to  the  author  to  be  essential 
in  determining  the  fair  value  for  use  in  fixing  rates. 

First. — To  conform  to  the  rulings  of  the  courts  the  basis  for 

;  rate-making  should  be  the  fair  present  value  of  the  property 
used,  regardless  of  the  amount  of  the  original  investment  in  utili- 
ties established  previous  to  the  present  public  regulation  regime. 
Second. — Present  value  for  rate-making  is  obtained  by  making 
deduction  for  absolute  depreciation  only;  ignoring  theoretical 
depreciation.  Absolute  depreciation  being  that  deterioration 
which  is  in  evidence,  existing  and  determined  by  inspection. 
Theoretical  depreciation  being  estimates  only,  based  on  assump- 
tions and  computations. 

Third. — Practically  every  utility  property  includes  certain  in- 
tangible non-physical  elements,  which  should  be  evaluated  and 
allowed  in  addition  to  the  material,  sensil)le  elements.  The 
value  of  the  non-physical  parts  may  vary  from  a  few  per  cent. 


rr^*v 


19805^ 


vi  PREFACE 

to  a  huiulrod  pvv  cent,  or  more  of  the  value  of  the  physical  parts 
of  a  property. 

The  author  has  certain  definite  views  as  to  the  principles  to 
Ix*  adopted  and  the  lines  to  be  followed  in  determining  values  to 
\)e  used  as  the  basis  of  rate-making.  Therefore,  believing  that 
these  views  will  ultimately  prevail  in  the  decisions  of  public 
authorities,  those  which  seem  wrong  in  principle  and  likely  to  be 
later  over-ruled  by  the  decision  of  final  courts,  have  not  neces- 
sarily been  referred  to  or  included  in  the  following  pages. 

It  maj^  seem  presumptious  on  the  part  of  any  one  but  an 
attornej''  to  criticize,  or  even  interpret,  decisions  rendered  by 
courts  or  commissions,  but  in  these  matters  an  engineer  who  has 
Ix^en  engaged  for  some  years  in  making  valuations,  giving  testi- 
mony thereon  before  courts  and  commissions,  associating  with 
attorneys  in  preparing  cases,  and  assisting  in  writing  briefs,  neces- 
sarily al)sorbs  some  legal  knowledge  and  has,  perhaps,  a  better 
understanding  of  what  is  practicable  in  the  construction  and 
operation  of  utility  property  than  a  mere  theorist.  Finally,  a 
knowledge  of  legal  decisions  and  procedure  must  be  fitted  to 
facts  and  figures  in  order  to  prepare  the  proper  basis  upon  which 
to  fix  rates. 

Herein  will  be  found  much  matter  that  was  originally  prepared 
by  the  author  in  discussing  papers  presented  before  engineering 
societies,  in  assisting  the  writing  of  legal  briefs,  or  publication 
in  other  form,  l)ut  it  is  hoped  that  as  here  presented,  it  will  tend 
to  make  an  orderly,  logical  argument  for  the  principles  involved. 

Henry  Floy. 

Nkw  York  City, 
March  1,   19 IG. 


CONTENTS 

Page 

Preface    v 

CHAPTER  I 

Introduction 1 

Basis  for  Rates — Right  of  Regulation. — Development  of  Law — 
Federal  Valuation. 

CHAPTER  11 

Definitions 21 

Explanatory — Value — Physical  or  Structural  Value — Scrap  or 
Salvage  Value — Wearing  Value — Service  Value — Present  Value — 
Original  Cost — Cost  to  Reproduce  New — Development  Expenses 
or  Overhead  Charges — Good-will — Going  Value — Depreciation — 
Classes  of  Depreciation — -Obsolescence. 

CHAPTER  III 

Fundamentals  in  Valuation 27 

Before  and  After  Regulation  Begins — Competition — Purpose 
Affects  Valuation — Gifts  and  Donations — Free  Service — Agency 
Theory. 

CHAPTER  IV 

Fair  Value  for  Rate-making 54 

Principles  Involved — Law  and  Method — Investment  not  Value — 
Basis  of  Value — Present  Value — Court  Decisions — Consolidated 
Gas  Case — Fair  Rate — Efficiency  in  Operation  and  Utilization — 
Value  of  Service. 

CHAPTER  V 

Cost  of  Reproduction 100 

Development  of  Theory — Reproduction  New — Construction 
Schedule — Inventory — Unit  Prices — Fluctuating  Prices— Contract- 
or's Profit — Engineering,  Architects'  Fees,  etc.^ — Omissions,  Inci- 
dentals and  Contingencies — Insurance — Development  Costs — 
Taxes — Preliminary  Expenses — Promotion — Financial  Costs — 
Overhead  Charges — Superseded  Plant. 


viii  .  COXTEXTS 

CHAl'TllR  VI 

Page 

Land,  Pavi.nm;  and  Watku  Rights 132 

Land  Values — Paving — Water  Rights. 

CHAPTER  VII 

Fhamhisks.  WoKKiNt;  Capital  and  Bond  Discounts       157 

Francliises — Working  Cajjital — Bond  Discount. 

CHAPTEH  Vlll 

GoiN<i  Value      177 

Cioing  Value  Must  be  Allowed — Going  Value  in  Rate  Cases — 
(ioing  Value,  Four  Meanings — Going  Value,  not  Plant  Operation 
— Going  \'alue  not  Rate  of  Return. 

CHAPTER  IX 

Dki'ueciatiun 235 

General  Di.scussion — "Absolute"  and  "Theoretical"  Deprecia- 
tion— Accruing  Depreciation  not  Allowed/ — Depreciation  Estimates 
Inaccurate — Minnesota  Rate  Cases — Public  Utility  Decisions — 
Individual  Opinion — Illustrations — Reserve  Funds — Depreciation 
Funds — Value  not  Fixed  by  Depreciation  Fund. 

Inukx 311 


VALUE  FOR  RATE-MAKING 

CHAPTER  I 
INTRODUCTION 

Basis  for  Rates. — The  determination  of  the  value  of  property 
used  in  serving  the  pubKc  has  become  a  very  general  requirement. 
The  purpose  of  such  determination  is  usually  to  permit  the  control 
of  public  utility  properties  through  municipal,  state  or  national 
regulatory  bodies.  Although  this  present  commission  form  of 
regulation  is  a  comparatively  recent  development,  it  is  predicated 
upon  the  principle  that  private  ownership  may  be  compelled  to 
provide  adequate  service  at  the  lowest  rates  that  will  furnish  a 
fair  return  upon  the  fair  value  of  the  property  devoted  to  public 
service.  It  will,  therefore,  be  recognized  that  the  determination 
of  property  values,  in  connection  with  rate-making,  is  made 
primarily  for  the  purpose  of  determining  the  amount  of  return 
to  be  allowed. 

While  the  fixing  of  a  fair  and  reasonable  return  may  seem  a 
complex  and  difficult  question,  nevertheless,  the  determination 
of  the  fair  value  of  property  is  still  more  complicated.  In  this 
connection  even  so  apparently  a  simple  and  elementary  matter, 
as  the  making  of  an  inventory  of  the  physical  property  of  a  utility, 
requires  great  care,  experience  and  expense.  The  work  must  be 
done  in  a  painstaking  manner,  involving  tedious  and  almost 
endless  detail,  costing  relatively  large  amounts  of  money,  if  the 
results  are  to  be  free  from  error,  and  capable  of  substantiation  in 
court.  The  opportunities  for  errors  in  making  an  inventory  are 
numberless,  due  not  alone  to  the  grade  and  experience  of  help 
that  must  be  employed,  in  order  to  keep  the  cost  within  boimds, 
but  also  to  the  human  element  which  seldom  attains  absolute 
accuracy.  Moreover,  in  many  instances,  lack  of  opportunity 
for  close  inspection,  impossibility  of  examining  unexposed  prop- 
erty, limitations  as  to  the  time  in  which  the  work  must  be 
completed,  multiplicity  of  items  and  opportunities  for  misunder- 
standing, increase  the  difficulties. 

1 


2  VALUE  FOR  RATE-MAKING 

In  order  to  fix  values,  even  though  the  inventory  is  complete, 
there  still  remain  questions  involved  in  its  proper  pricing.  Some 
of  the  difficulties  of  fixing  upon  fair  and  proper  costs  are  due  to 
differences  in  costs  of  the  same  item  at  different  times  in  different 
localities,  or  under  different  conditions  of  installation;  also  as  to 
whether  the  original  cost,  to-day's  quoted  prices,  or  prices  based 
on  the  average  over  a  number  of  years,  or  the  present  trend, 
shall  be  used;  also  to  the  fact  that  differences  in  price  are  made  to 
different  parties  for  the  same  item,  delivered  at  the  same  place, 
at  the  same  time.  In  addition  to  these  difficulties,  percentages 
must  be  adopted  to  cover  some  allowances  that  have  to  be  made 
for  items  too  small  to  list  in  the  inventory,  for  contingencies, 
omissions,  engineering,  interest  and  taxes  during  construction, 
and  other  like  items.  Furthermore,  the  complicated  cost  of 
developing  the  business,  which  is  generallj^  recognized  as  proper 
to  include  as  a  part  of  the  value  of  a  going  utility,  must  be  com- 
puted or  otherwise  arrived  at,  and  finally  questions  as  to  the 
amount  to  be  deducted  for  depreciation,  about  which  the  widest 
differences  of  opinion  prevail,  must  be  estimated.  In  order  to 
comply  with  the  rulings  of  the  court,  consideration  must  be 
given  original  investment,  the  amount  of  outstanding  stock,  bonds 
or  other  securities,  as  well  as  the  revenue  and  operating  expenses, 
before  fair  value  can  eventually  ])e  legally  determined. 

The  primary  cause  of  the  existing,  widespread  agitation,  which 
may  almost  be  called  a  mania,  for  the  valuation  of  public  utility 
property  arises  from  a  determination  to  secure  a  readjustment  of 
charges  for  or  quality  in  the  service,  being  rendered.  This  de- 
termination, while  frequently  the  expression  of  a  proper  and 
reasonable  demand  on  the  part  of  the  public,  is  in  too  many 
instances  merely  the  agitation  of  political  office  seekers  or  misin- 
formed philanthropists  aroused  by  unintentional  errors  or 
deliberate  wrongdoing  of  utility  managements.  Frequently, 
changes  are  demanded  through  ignorance  of  what  may  be  fairly 
and  practically  required  of  utility  corporations.  A  greater  readi- 
ness on  the  part  of  utility  managements  to  impart  information 
as  to  their  business  and  a  greater  willingness  on  the  part  of  the 
public  to  study  conditions  and  learn  facts  and  possibilities,  would 
result  in  the  avoidance  of  many  bitter  controversies  between  the 
public  and  the  utilities.  Unnecessarily  large  expenditures  of 
effort  and  money  are  made  by  public  authorities  and  required  of 
corporations  in  valuations  made  necessary  by  rate  controversies 


INTRODUCTION  3 

originated  by  individuals,  posing  as  protectors  of  the  general 
public,  olthough  the  latter  maj''  be  well  satisfied  with  existing 
conditions.^  There  can  be  no  question  but  that  many  valuations 
of  phj'sical  property  are  to-day  being  made  which  cannot  be  of 
much  practical  use,  because  not  made  at  the  time  rates  are  to  be 
determined,  or  a  sale  effected.  Moreover,  in  some  cases,  where 
fair  valuations  of  utilities  could  properly  be  used  for  adjusting 
rates  or  fixing  values  for  sale,  improper  valuations  are  being 
unfairly  and  illegitimately  used.  This  is  brought  about  by 
the  financial  inability  or  fear  of  a  greater  evil  than  too  low  a 
valuation,  on  the  part  of  the  corporations.  They,  therefore, 
refrain  from  attacking  such  improper  valuations,  which,  being 
allowed  to  stand,  thereby  become  legalized  through  commission 
or  even  court  decisions,  A  frequent  instance  of  the  error  to  be 
found  in  the  rulings  of  public  authorities  results  from  their 
failure  to  add  to  the  physical  values  the  other  and  equally  im- 
portant non-physical  values,  the  sum  of  which  two  elements 
makes  up  the  total  value  of  an  operating  utility. 

An  excellent  statement  of  the  basis  of  value  for  rate-making 
was  made  by  President  Wilson  when  he  ran  for  Governor  of  New 
Jersey  in  1911.  A  voter  of  the  State  propounded  this  question 
to  him  in  an  open  letter: 

"Do  you  believe  that  all  the  public  utilities  of  New  Jersey  ought  to 
be  valued  with  regard  to  their  physical  property  alone,  and  on  the  value 
thus  found  rates  should  be  fixed,  which  should  allow  them  6  per  cent, 
on  that  value?" 

President  Wilson's  reply  was: 

"No,  I  believe  the  physical  value  has  an  important  bearing  upon  the 
question,  but  I  also  think  that  all  the  physical,  financial  and  economic 
circumstances  should  be  considered  in  connection  therewith."- 

In  fixing  rates,  valuation  of  the  property  is  by  no  means  the 
only  requirement.  The  determination  of  a  fair  and  reasonable 
rate  necessitates,  in  addition  to  the  valuation  of  the  property, 

1  The  single  complaint  of  Mayor  Fuhrman  of  Buffalo  as  to  the  service  and  rates  of  the 
Cataract  Power  &  Conduit  Company  of  Buffalo  compelled  the  corporation  to  spend  thousands 
of  dollars  in  presenting  its  case  before  the  Public  Service  Commission,  with  the  resulting 
illegal  decision  reducing  rates  28  per  cent.,  although  the  evidence  showed  that  not  a  single 
customer  of  the  corporation  complained  of  the  excellent  service  or  of  the  extraordinarily 
low  tariffs  (the  average  price  received  per  kw.-hr.  sold  was  $0.00711)  but  on  the  contrary, 
unanimously  commended  the  corporation. 

^  Mr.  T.  N.  McCarter  in  an  address  before  the  West  Side  Y.  M.  C.  A.  of  New  York  City, 
Apr.  13,  1914. 


4  VALUE  FOR  RATE-MAKING 

the  passing  of  judgment  upon  all  kinds  of  operating  conditions, 
the  auditing  of  accounts  and  records,  which  presupposes  proper 
accounting  systems,  the  collection  and  analysis  from  various 
independent  sources,  of  data  relating  to  financial  and  operating 
factors  of  similar  properties,  and  then  the  formation  of  a  judg- 
ment by  the  just  and  wise  weighing  and  proportioning  of  the 
various  elements  proper  in  fixing  the  rate  from  a  consideration 
of  the  particular  industrial,  operating  and  financial  local  con- 
ditions. The  principles  to  be  used  in  ascertaining  value  for 
rate-making  and  their  application  are  important  not  only  to 
the  utilities  but  also  to  the  customers  served. 

Right  of  Regulation. — The  theory  of  State  or  Federal  control 
and  regulation  of  corporations  is  not  new,  although  the  principle 
has  recently  been  greatly  broadened.  Despite  the  feeling  that  a 
corporation  or  a  monopoly,  like  an  individual,  may  charge  ''what 
the  traffic  will  bear,"  it  is  generally  recognized  and  now  univer- 
sally held  by  the  courts,  that  with  reference  to  those  things  that 
have  come  to  be  considered  more  or  less  as  "necessities  of  life," 
the  public  has  the  right  to  demand  the  service  at  such  price  as 
will  insure  to  the  owner  under  all  considerations  of  the  case, 
merely  a  fair  return  upon  the  value  of  his  property. 

The  authority  and  power  to  regulate  public  utilities  lies  in  the 
Legislature.  Consequently,  the  Legislature  may  deputize  its 
powers  to  a  commission,  or  other  delegated  authority,  but  it  is, 
of  course,  axiomatic  that  the  Legislature  cannot  delegate  powers 
which  it  does  not  possess.  Moreover,  any  State  Legislature  is 
restricted  in  its  power  by  the  State  or  Federal  Constitutions. 
Therefore,  a  commission  attempting  to  evaluate  public  utility 
property  and  determine  rates  to  be  charged  for  service  rendered 
thereby,  is  limited  and  controlled  in  its  action  by  the  authority 
delegated  to  it  by  the  Legislative  body.  State  or  Federal,  ap- 
pointing it,  and  it  has  only  those  powers  which  are  not  contrary 
to  the  constitutional  provisions  of  the  State  or  Federal  Govern- 
ment. The  United  States  Supreme  Court  has  clearly  recog- 
nized these  relations  and  determined  this  principle  in  City  of 
Worcester  vs.  Worcester  Consolidated  Street  Railway  Companj'', 
196  U.  S.,  548. 

"The  (luostion  thon  arising  is,  whether  the  legislature,  in  the  exercise 
of  its  general  legislative  power,  could  abrogate  the  provisions  of  the 
contract  between  the  city  and  railroad  company  with  the  assent  of 
the  latter,  and  provide  another  and  a  different  method  for  the  paving 


INTRODUCTION  5 

and  repairing  of  the  streets  through  which  the  tracks  of  the  railroad 
company  were  laid  under  the  permit  of  their  extended  location.  We 
have  no  doubt  that  the  legislature  of  the  Commonwealth  has  that  power. 
A  municipal  corporation  is  simply  a  political  subdivision  of  the  State, 
and  exists  by  virtue  of  the  exercise  of  the  power  of  the  State  through 
its  legislative  department.  The  legislature  could  at  any  time  terminate 
the  existence  of  the  corporation  (the  city)  itself,  and  provide  other  and 
different  means  for  the  government  of  the  district  comprised  within 
the  limits  of  the  former  city." 

The  Legislature,  not  having  divested  itself,  but  simply  delegat- 
ing its  authority  to  specified  agents,  such  agents  or  commission 
are  clothed  with  the  power  possessed  by  the  authorizing  body  for 
the  purpose  of  protecting  the  public  against  unjust  practices 
and  methods  in  connection  with  the  furnishing  of  service  by 
utilities  as  well  as  protecting  the  utilities  against  unreasonable 
demands  and  unduly  low  rates  sought  by  the  public.  In  general, 
the  people  are  entitled  in  law  and  equity  to  adequate  service  at 
fair  rates,  in  consideration  of  which  the  utility  is  entitled  not  only 
to  the  protection  of  its  property,  but  also  for  the  use  thereof,  to 
an  equitable  rate  of  interest  plus  a  reward,  which  together  make 
up  the  fair  rate  of  return. 

Although  the  public's  right  to  regulate  public  service  corpora- 
tions is  no  longer  questioned  and  the  establishment  of  correct 
principles  for  determining  the  value  of  the  property  used  is  most 
important,  the  allowance  of  a  fair  and  proper  rate  of  return  is 
most  essential  in  assuring  efficiency  and  high  quality  of  service.  ^ 
Sacrificing  high-class  service  for  a  somewhat  lower  rate  results 
ultimately  in  dissatisfaction  to  the  public  as  well  as  the  utilities. 

The  right  of  the  public  to  regulate  any  corporation  depends 
only  upon  the  character  of  its  business  and  to  what  extent  it 
effects  the  public  interest.  The  recent  decision  of  the  Supreme 
Court  upholding,  because  of  the  peculiar  and  close  relation  of  this 
business  to  the  public,  the  right  of  the  State  of  Kansas  to  regulate 
fire  insurance  rates,  indicates  the  extent  to  which  the  principles  of 
public  regulation  has  proceeded.  Although  the  opinion  was 
divided  in  this  case  the  majority  of  the  judges  upheld  the  right 
of  legislative  control  to  fix  insurance  contracts,  in  view  of  the 
fact  that  they  are  a  public  necessity  and  monopolistic  in  char- 
acter, under  the  present  system  whereby  rates  and  contracts 
are  fixed  by  the  agreement  of  the  underwriters.  While  it  may 
be  questioned  that  the  public  should  generally  fix  prices,  wages 


6  VA L  r^E  FOR  RA  TE-MA KING 

and  rates,  the  progressive  spirit  of  the  decision  makes  clear  the 
fact  that  as  conditions  change — whatever  they  may  have  been — 
public  interest  begets  the  public's  power  of  control.  The  class 
of  corporations  in  which  the  public  has  a  regulating  interest  is 
indicated  by  the  following  extract  from  the  insurance  rate 
decision  above  referred  to: 

"The  list  of  rate-regulated  corporations  is  not  too  long  to  be  here 
given.  It  includes  canals,  waterways  and  booms;  bridges  and  ferries; 
wharves,  docks,  elevators  and  stockyards;  telegraph,  telephone,  elec- 
tric, gas  and  oil  lines;  turnpikes,  railroads  and  the  various  forms  of 
common  carriers,  including  express  and  cabs.  To  these  should  be 
added  the  case  of  the  innkeeper  (as  to  which  no  American  case  has  been 
found  where  the  constitutional  question  as  to  the  right  to  fix  his  rate 
has  been  considered),  the  confessedly  close  case  of  the  irrigation  ditches 
for  distributing  water  (193  U.  S.  379),  and  the  toll  mills  acts.  This, 
of  course,  does  not  include  the  case  of  condemnation  for  governmental 
purposes  or  for  roads  and  waj's  where  no  ciuestion  of  rates  is  involved. 
There  may  be  other  instances  not  found,  but  it  is  believed  that  the  fore- 
going enumeration  exhausts  the  list  of  what  has  heretofore  been  treated 
as  a  public  business,  justifying  exercise  of  the  price  fixing  power  against 
persons  or  corporations. 

"It  is  to  be  noted  that  in  each  instance  the  power  to  regulate  rates  is 
exercised  against  a  business  which  in  every  case  used  tangible  property 
devoted  to  a  public  use.  Some  of  them  had  a  monopoly  (Spring  Water 
Co.  vs.  Schlotter,  1 10  U.  S.  354).  Some  of  them  had  franchises.  Most 
of  them  used  public  ways  or  employed  property  whicli  they  acquired 
by  virtue  of  the  power  of  eminent  domain.  They  were  therefore  :  ub- 
ject  to  the  correlative  obligations  to  have  the  use,  of  what  had  been 
taken  by  law,  fixed  by  law.  And  as  further  pointing  out  the  character- 
istics of  the  public  use  justifying  the  fixing  of  prices,  it  will  be  noted  that, 
with  the  exception  of  toll  mills  (which,  however,  do  not  emploj'  property 
devoted  to  a  public  use),  they  all  have  direct  relations  to  the  business 
of  the  facilities  of  transportation  or  distribution — to  transportation  by 
carriers  of  passengers,  goods  or  intelligence  by  vehicle  or  wire — to  dis- 
tribution of  water,  gas  or  electricity  through  ditch,  pipe  or  wire;  to 
wharfage,  storage,  or  accommodation  of  property  before  the  journey  be- 
gins, when  it  ends,  or  along  the  way. 

"Wlicn  thus  enumerated,  they  appear  to  be  grouped  around  the  com- 
mon carrier  as  the  tj'pical  business  and  all  cmph)ying  in  some  way 
property  devoted  to  a  public  use. 

"It  will  be  seen,  too,  that  the  size  of  the  business  is  unimportant,  for 
the  fares  of  a  cabman,  employing  a  broken-down  horse  and  a  dilapidated 
vehicle  can  be  fixed  by  law  as  well  as  the  rates  of  a  railroad  with  niilhons 


INTRODUCTION  7 

of  capital  and  tliuusands  of  cars  transporting  persons  and  property 
across  the  continent."^ 

The  earliest  appraisals  or  valuations  of  corporation  property 
were  made  in  connection  with  the  purchase  and  sale  of  water- 
works. Later,  the  excessive  profits  made  or  asserted  to  be  made 
from  various  utility  properties  resulted  in  demands  for  reduc- 
tions in  the  tariffs  being  charged  for  the  service  rendered;  conse- 
quently valuations  were  required  for  the  purpose  of  ascertaining 
whether  or  not  the  tariffs  charged  produced  unreasonably  large 
returns  upon  the  values  of  the  respective  properties.  This 
right  of  the  public  to  regulate  tariffs  was  upheld  by  the  courts 
on  the  ground  that 

"property  does  become  clothed  with  a  public  interest  when  used  in  a 
manner  to  make  it  of  public  consequence  and  effect  the  community  at 
large. "^ 

Development  of  Law. — The  appraising  of  corporation  property, 
for  the  purpose  of  establishing  the  fair  value  of  such  property, 
to  be  used  in  establishing  the  just  basis  of  financial  transactions 
between  the  public  and  the  corporations  has  been  a  gradual  de- 
velopment and  hence,  naturally  the  more  elemental  principles 
were  first  recognized  and  established.  But  even  to-day,  although 
the  principle  of  establishing  the  fair  value  of  corporation  property 
is  practically  universally  recognized  and  acknowledged  as  a 
necessary  preliminary  step  for  determining  the  tariff  to  be 
charged  for  a  given  service,  nevertheless,  the  basis  of  such  valua- 
tion and  the  various  elements  entering  therein  are  not  by  any 
means  agreed  upon,  appreciated  or  all  allowed  for  in  most  cases 
where  regulating  authorities  have  been  and  are  establishing  values 
for  rate-making. 

The  earlier  uses  of  valuations  were  made  in  connection  with 
the  most  simple  form  of  corporation  property  where  the  physical 
property  represented  all  or  nearly  all  of  the  value  of  the  invest- 
ment. Under  these  conditions,  the  restriction  of  the  meaning 
of  valuation  to  the  value  of  the  physical  property  was  not  only 
natural,  but  in  many  cases  fair,  and  yet,  even  in  the  earliest 
decisions  of  the  courts,  there  was  recognized  the  fact  that  in  addi- 
tion  to   the   physical    property   upon   which   the   owners   were 

'  German   Alliance   Insurance   Co.   vs.   Ike  Lewis,   Superintendent   of   Insurance,   of  the 
State  of  Kansas.     Decided  Apr.  20,  1914. 
"^  Munn  vs.  Illinois,  94  U.  S.  113. 


8  VALUE  FOR  RATE-MAKIXG 

entitled  to  a  return,  there  might  also  be  included  in  the  tariff  a 
proper  charge  for  the  value  of  the  ser%'ice  rendered,  pro\'ided 
such  charge  was  reasonable. 

One  of  the  simplest  and  earUer  cases  determining  the  principles 
of  valuation  of  corporation  property  for  use  in  ser\'ice  to  the 
public  that  was  passed  upon  by  the  Supreme  Court  was  in  the 
case  of  a  turnpike  road  company,  which  had  constructed  and  was 
maintaining  a  turnpike  extending  from  CoWngton  to  Lexington, 
Kentucky.  After  constructing  and  operating  the  turnpike  for  a 
number  of  years,  the  public  felt  that  the  charges  by  the  corpora- 
tion were  excessive  in  view  of  the  increasing  traffic,  and  the  Legis- 
lature passed  an  Act  to  compel  the  corporation  to  reduce  its 
tariffs.  In  this  case,  while  the  elements  of  organization  were 
most  simple,  the  annual  expenses — primarily  those  of  mainte- 
nance— and  the  value  of  the  corporation  property  were  prac- 
tically all  e^^denced  by  physical  property,  thus  indicating  the 
most  elementary-  form  of  value,  nevertheless,  the  Court  recog- 
nized that  the  value  of  the  service  should  be  considered. 

"So  that  the  right  of  the  public  to  use  the  defendant's  turnpike  upon 
paj-ment  of  such  tolls  as  in  \new  of  the  nature  and  value  of  the  ser\-ice 
rendered  by  the  company  are  reasonable,  is  an  element  in  the  general 
inquiry  whether  the  rates  established  by  law  are  unjust  or  unreasonable. 
That  inquirj'  also  involves  other  considerations,  such,  for  instance,  as 
the  reasonable  cost  of  maintaining  the  road  in  good  condition  for  public 
use,  and  the  amount  that  may  have  been  really  and  necessarily  invested 
in  the  enterprise.  In  short,  each  case  must  depend  upon  its  special 
facts.  *****•■! 

Formerly,  the  courts  held  that  where  property  was  used  for  the 
ser%'ice  of  the  public,  the  regulation  of  rates  to  be  charged  there- 
for lay  entirely  in  the  discretion  of  the  proper  legislative  body 
and  regulation  in  these  matters  was  beyond  the  power  of  the 
courts. 

''It  is  insisted,  however,  that  the  owner  of  property  is  entitled  to  a 
reasonable  comp>ensation  for  its  use,  even  though  it  be  clothed  with  a 
public  interest,  and  that  what  is  reasonable  is  a  judicial  and  not  a  legis- 
lative question. 

As  has  already  been  shown,  the  practice  has  been  otherwise.''^ 

Later,  however,  the  decisions  of  the  courts  establishing  this 
principle  were  re\'ised,  because  it  was  recognized  that  the  fixing 

'  Covington  4  Lexington  Turnpike  Road  Company  vs.  Sanford,  164  U.  S.  597. 
*  Munn  vs.  IllinoU  W,  L'.  S.  133. 


ISTRODUCTION  9 

of  an  unfairly  low  rate  would  result  in  unfairly  depreciating  the 
value  of  the  property  used  in  rendering  the  service,  contrary  to 
the  Fourteenth  Amendment. 

In  the  case  of  the  Chicago,  Milwaukee  &  St.  Paul  Railroad 
Company,^  it  was  definitely  argued  that 

"insofar  as  it  (the  company)  is  definitely  deprived  of  the  lawful 
use  of  its  prop)erty.  while  other  pyersons  are  permitted  to  receive 
reasonable  profits  upon  their  invested  capital,  the  compan}'  is  deprived 
of  the  equal  protection  of  the  laws,' 

that  is,  if  the  company  was  deprived  of  its  right  to  charge 
reasonable  rates  for  the  use  of  its  property,  it  was  deprived  of 
the  lawful  use  of  that  property  and  consequently  in  substance 
and  effect  of  the  property  itself.  The  Supreme  Court,  therefore, 
reversed  its  pre\'ious  decisions  contrary-  to  this  contention  and  in 
several  other  and  later  cases  reaffirmed  this  new  position,  where 
it  spoke  as  follows: 

"The^e  cases  all  support  the  proposition  that  while  it  is  not  the  pro- 
vince of  the  courts  to  enter  upn^n  the  merely  administrative  duty  of 
framing  a  tariff  of  rates  for  carriage,  it  is  within  the  scope  of  judicial 
power  and  a  part  of  the  judicial  duty  to  restrain  an}-thing  which,  in  the 
form  of  a  regulation  of  rates,  operates  to  deny  to  the  owners  of  property 
invested  in  the  business  of  transportation  that  equal  protection  which 
is  the  constitutional  right  of  all  owners  of  other  property.  There  is 
nothing  new  or  strange  in  this.  It  has  always  been  a  part  of  the  judi- 
cial function  to  determine  whether  the  act  of  one  party  (whether  that 
party  be  a  single  indi^^dual,  an  organized  body,  or  the  public  as  a 
whole)  operates  to  divest  the  other  party  of  any  rights  of  jjerson  or 
property.  In  everj'  constitution  is  the  guarantee  against  the  taking 
of  private  prop>erty  for  public  purposes  without  just  comp)ensation. 
The  equal  protection  of  the  laws  which,  by  the  Fourteenth  Amendment, 
no  State  can  deny  to  the  indi\idual,  forbids  legislation,  in  whatever  form 
it  maj'  be  enacted,  by  which  the  property  of  one  indi\idual  is,  without 
compensation,  wrested  from  him  for  the  benefit  of  another,  or  of  the 
pubhc.  ■= 

"That  there  is  a  remedy  in  the  courts  for  rehef  against  legislation 
establishing  a  tariff  of  rates  which  is  so  unreasonable  as  to  practically 
destroy  the  value  of  property  of  companies  engaged  in  the  carrj-ing 
business,  and  that  esp>ecially  may  the  courts  of  the  United  States  treat 
such  a  question  as  a  judicial  one,  and  hold  such  acts  of  legislation  to  be 
in  conflict  with  the  Constitution  of  the  United  States,  as  depriving  the 

>  Chicago.  Milwaukee  &  St.  Paul  R.  R.  Co..  \-s.  Minnesota.  134  L".  S    418. 
*  Reagan  %'s.  Farmers"  Loan  &  Trust  Co..  154  U.  S.  399. 


10  VALUE  FOR  RATE-MAKING 

companies  of  their  property  without  due  process  of  law,  and  as  depriving 
them  of  the  equal  protection  of  the  laws."^ 

The  Federal  and  Circuit  Courts,  following  the  Supreme  Court's 
decisions  in  these  matters,  have  upheld  the  theory  that  a  rate  too 
low  to  permit  a  fair  return  on  the  value  of  the  property  being 
used  for  the  service  of  the  public  is  confiscation  of  that  property. 

"A  State  enactment,  or  regulations  made  under  the  authority'  of  a 
State  enactment,  establishing  rates  for  the  transportation  of  persons 
or  propert}^  by  railroad  that  will  not  admit  of  the  carrier  earning  such 
compensation  as  under  all  the  circumstances  is  just  to  it  and  the  public, 
would  deprive  such  carrier  of  its  property  without  due  process  of  law  and 
deny  to  it  the  equal  protection  of  the  laws,  and  would  therefore  be  repug- 
nant to  the  Fourteenth  Amendment  of  the  Constitution  of  the  United 
States."2 

"As  the  right  to  use  property  for  any  lawful  purpose  to  the  extent  of 
the  realization  therefrom  of  a  return  or  reward,  commensurate  with  the 
reasonable  and  just  value  of  such  use,  is  an  element  of  property,  property 
itself  pro  tanto,  since,  without  the  right  of  such  use,  it  would  be  wholly 
or  partially  valueless  according  to  the  extent  of  the  restraint  upon  its 
use,  deprivation  of  the  use  thereof,  or  denial  of  the  power  to  each  such 
reasonable  and  just  return  or  reward,  by  the  use  thereof,  in  whole  or  in 
part,  without  compensation  therefor,  amounts  to  such  wrongful  taking 
thereof,  and,  therefore,  to  confiscation  within  the  meaning  of  the  deci- 
sions in  cases  of  this  kind.  To  constitute  such  confiscation,  the  taking 
need  not  extend  to  the  corpus  of  the  property  nor  total  deprivation  of 
reward  for  the  use  thereof.  If  the  law  renders  it  impossible  to  obtain 
from  the  use  of  the  property  a  reasonable  and  fair  return,  it  is  confisca- 
tory^ in  its  operation  and  effect,  though  vahd  on  its  face.  The  extent 
of  such  deprivation  is  not  the  test.  Whether  a  statute  is  thus  confisca- 
tory does  not  depend  upon  the  amount  it  takes,  in  violation  of  the  Con- 
stitution or  the  extent  to  which  it  interferes  with  the  right  of  use  of 
property,  guaranteed  by  the  organic  law.  It  is  void  if  it  so  takes  any 
at  all  or  so  interferes  to  any  extent  whatever.  It  is  condemned  not  by 
the  extent  of  the  pecuniary  injury  wrought,  but  by  its  transgression  of 
constitutional  limits,  its  invasion  of  a  constitutional  right,  as  sacred  to 
corporations  as  to  the  humblest  citizen  of  the  land,  and  justly  so,  for 
the  reason,  among  others,  that  the  property  of  corporations  is  in  fact 
the  property  of  citizens,  and  the  laws  cannot,  and  ought  not,  in  its 
ultimate  results,  to  favor  one  citizen  or  class  of  citizens  over  another."^ 

"The  use  and  profits  of  property  arc  themselves  property,  and  are 

'  St.  Louis  &  San  Francisco  Railway  vs.  Gill,  156  U.  S.  649. 

^  Smyth  vs.  Ames,  169  U.  S.  526. 

'  Coal  &  Coke  Ity.  Co.,  vs.  Conley,  57  S.  E.  (W.  Va.)   0.39. 


INTRODUCTION  11 

alike  under  the  protection  of  the  Federal  Constitution The 

value  of  property  is  the  value  of  its  uses.''^ 

"The  value  of  property  and  of  investment  in  every  form  is  measured 
by  the  value  of  its  use,  not  by  its  use  divorced  from  the  value  thereof. "^ 

"But  the  value  of  property  results  from  tlio  use  to  which  it  is  put 
and  varies  with  the  profitableness  of  that  use,  present  and  prospective, 
actual  and  anticipated.  There  is  no  pecuniary  value  outside  of  that 
which  results  from  such  use."' 

The  title  to  ownership  of  property  of  a  pii})lic  utility  is  as 
complete  as  that  of  any  individual   for  the  courts  have  hekl: 

"The  property  (of  the  Gas  Company)  now  under  consideration  is 
as  much  the  private  property  of  this  complainant  as  are  the  belong- 
ings of  any  private  citizen."^ 

The  difference  between  the  rights  of  an  individual  and  a 
public  utility  to  use  and  enjoy  their  respective  properties  is 
that  the  former  is  not  limited  as  to  the  amount  of  return  allowed, 
because  that  is  not  a  matter  of  public  interest,  but  the  latter, 
being  a  corporation  in  whose  operations  the  public  is  interested, 
therefore  may  properly  be  restricted  in  its  earnings  to  a  reason- 
able return  upon  the  value  of  the  property  used  in  rendering 
service. 

"It  is  no  longer  open  to  dispute  that  under  the  Constitution  'what 
the  company  is  entitled  to  demand,  in  order  that  it  may  have  just  com- 
pensation, is  a  fair  return  upon  the  reasonable  value  of  the  property  at 
the  time  it  is  being  used  for  the  public'  "* 

"What  the  company  is  entitled  to  demand,  in  order  that  it  may  have 
just  compensation,  is  a  fair  return  upon  the  reasonable  value  of  the 
property  at  the  time  it  is  being  used  for  the  public."^ 

Federal  Valuation. — One  of  the  most  important  public  ques- 
tions at  present  is  the  proper  charges  for  transportation  to  be 
made  by  utility  corporations.  This  subject  has  rapidly  de- 
veloped during  the  last  few  years  and  reached  its  culmination  in 
an  amendment  passed  by  Congress  early  in  1913,  providing  for  a 
valuation  by  the  Federal  Government  of  the  several  classes  of 
property  of  all  common  carriers;  namely,  steam  and  electric  rail- 

'  Spring  Valley  Water  Works  vs.  City,  etc.,  of  San  Francisco,  102  Fed.  144,  158. 

^Shepard  vs.  Northern  Pacific  Ry.  Co.,  184  Fed.  765,  811. 

^  Cleveland,  Cincinnati,  Chicago  &  St.  Louis  Ry.  Co.  vs.  Backus,  154  U.  S.  439,  at  p.  445. 

^  Consolidated  Gas  Co.  vs.  New  York,  157  Fed.  854. 

^  San  Diego  Land  &  Town  Co.  vs.  Jasper,  189  U.  S.  442. 

^  San  Diego  Land  &  Town  Co.  vs.  National  City,  174  U.  S.  739. 


12  VALUE  FOR  RATE-MAKING 

roads,  navigation  companies,  express  companies,  telephone  com- 
panies, etc.,  doing  an  interstate  business.  This  amendment  is  so 
far-reaching  and  is  destined  to  become  so  important  that  it  is 
herewith  reproduced  at  length. 

An  Act  To  amend  an  Act  entitled  "An  Act  to  regulate  commerce," 
approved  Februiiry  fourth,  eighteen  hundred  and  eighty-seven,  and 
all  Acts  amendatory  thereof  by  providing  for  a  valuation  of  the  several 
classes  of  property  of  carriers  subject  thereto  and  securing  information 
concerning  their  stocks,  bonds,  and  other  securities. 

Be  it  enacted  by  the  Senate  and  House  of  Representatives  of  the  United 
iStates  of  America  in  Congress  assembled,  That  the  Act  entitled  "An  Act 
to  regulate  commerce,"  approved  February  fourth,  eighteen  hundred 
and  eighty-seven,  as  amended,  be  further  amended  by  adding  thereto 
a  new  section,  to  be  known  as  section  nineteen  a,  and  to  read  as  follows : 

"Sec.  19a.  That  the  commission  shall,  as  hereinafter  provided, 
investigate,  ascertain,  and  report  the  value  of  all  the  property  owned 
or  used  by  every  common  carrier  subject  to  the  provisions  of  this  Act. 
To  enable  the  commission  to  make  such  investigation  and  report,  it 
is  authorized  to  employ  such  experts  and  other  assistants  as  may  be 
necessary.  The  commission  may  appoint  examiners  who  shall  have 
power  to  administer  oaths,  examine  witnesses,  and  take  testimony. 
The  commission  shall  make  an  inventory  which  shall  list  the  property 
of  every  common  carrier  subject  to  the  provisions  of  this  Act  in  detail, 
and  show  the  value  thereof  as  hereinafter  provided,  and  shall  classify 
the  physical  property,  as  nearly  as  practicable,  in  conformity  with  the 
classification  of  expenditures  for  road  and  equipment,  as  prescribed  bj^ 
the  Interstate  Commerce  Commission. 

"First.  In  such  investigation  said  commission  shall  ascertain  and 
report  in  detail  as  to  each  piece  of  property  owned  or  used  by  said 
common  carrier  for  its  purposes  as  a  common  carrier,  the  original  cost 
to  date,  the  cost  of  reproduction  new,  the  cost  of  reproduction  less 
depreciation,  and  an  analysis  of  the  methods  by  which  these  several 
costs  are  obtained,  and  the  reason  for  their  differences,  if  any.  The 
commission  shall  in  like  manner  ascertain  and  report  separately  otlier 
values,  and  elements  of  value,  if  any,  of  tlie  property  of  such  common 
carrier,  and  an  anal3\sis  of  the  metliods  of  valuation  emplo,yed,  and  of 
the  reasons  for  any  differences  between  any  such  value,  and  each  of 
the  foregoing  cost  values. 

"Second.  Such  investigation  and  report  shall  state  in  detail  and 
separately  from  improvements  the  original  cost  of  all  lands,  rights-of- 
way,  and  terminals  owned  or  used  for  the  purposes  of  a  common  car- 
rier, and  ascertained  as  of  the  time  of  dedication  to  public  use,  and  the 
present  value  of  the  same,  and  separately  the  original  and  present  cost 


INTRODUCTION  13 

of  condemnation  and  damages  or  of  purchase  in  excess  of  such  orif^iiial 
cost  or  present  value. 

"Third.  Such  investigation  and  report  shall  show  separately  the 
property  held  for  purposes  other  than  those  of  a  common  carrier,  and 
the  original  cost  and  present  value  of  the  same,  together  with  an  analysis 
of  the  methods  of  valuation  employed. 

"Fourth.  In  ascertaining  the  original  cost  to  date  of  the  property 
of  such  common  carrier  the  commission,  in  addition  to  such  other  ele- 
ments as  it  may  deem  necessary,  shall  investigate  and  report  upon  the 
history  and  organization  of  the  present  and  of  anj'  previous  corporation 
operating  such  property;  upon  any  increases  or  decreases  of  stocks, 
bonds,  or  other  securities,  in  any  reorganization;  upon  moneys  re- 
ceived by  any  such  corporation  by  reason  of  any  issues  of  stocks, 
bonds,  or  other  securities;  upon  the  syndicating,  banking,  and  other 
financial  arrangements  under  which  such  issues  were  made  and  the 
expense  thereof;  and  upon  the  net  and  gross  earnings  of  such  corpora- 
tions; and  shall  also  ascertain  and  report  in  such  details  as  may  be 
determined  by  the  commission  upon  the  expenditure  of  all  moneys 
and  the  purposes  for  which  the  same  were  expended. 

"Fifth.  The  commission  shall  ascertain  and  report  the  amount  and 
value  of  any  aid,  gift,  grant  of  right-of-way,  or  donation,  made  to  any 
such  common  carrier,  or  to  any  previous  corporation  operating  such 
property,  by  the  Government  of  the  United  States  or  by  any  State, 
county,  or  municipal  government,  or  by  individuals,  associations,  or 
corporations;  and  it  shall  also  ascertain  and  report  the  grants  of  land 
to  any  such  common  carrier,  or  any  previous  corporation  operating 
such  property,  by  the  Government  of  the  United  States,  or  by  any 
State,  county,  or  municipal  government,  and  the  amount  of  money 
derived  from  the  sale  of  any  portion  of  such  grants  and  the  value  of 
the  unsold  portion  thereof  at  the  time  acquired  and  at  the  present 
time,  also,  the  amount  and  value  of  any  concession  and  allowance 
made  by  such  common  carrier  to  the  Government  of  the  United  States, 
or  to  any  State,  county,  or  municipal  government  in  consideration 
of  such  aid,  gift,  grant,  or  donation. 

"Except  as  herein  otherwise  provided,  the  commission  shall  have 
power  to  prescribe  the  method  of  procedure  to  be  followed  in  the  con- 
duct of  the  investigation,  the  form  in  which  the  results  of  the  valuation 
shall  be  submitted,  and  the  classification  of  the  elements  that  consti- 
tute the  ascertained  value,  and  such  investigation  shall  show  the  value 
of  the  property  of  every  common  carrier  as  a  whole  and  separately  the 
value  of  its  property  in  each  of  the  several  States  and  Territories 
and  the  District  of  Columbia,  classified  and  in  detail  as  herein 
required. 

"Such  investigation  shall  be  commenced  within  sixty  days  after 
the  approval  of  this  Act  and  shall  he  prosecuted  with  diligence  and 


14  VALUE  FOR  RATE-MAKING 

thoroughness,  and  the  result  thereof  reported  to  Congress  at  the  be- 
ginning of  each  regular  session  thereafter  until  completed. 

"Every  common  carrier  subject  to  the  provisions  of  this  Act  shall 
furnish  to  the  commission  or  its  agents  from  time  to  time  and  as  the 
commission  may  require  maps,  profiles,  contracts,  reports  of  engineers, 
and  any  other  documents,  records,  and  papers,  or  copies  of  any  or 
all  of  the  same,  in  aid  of  such  investigation  and  determination  of  the 
value  of  the  property  of  said  common  carrier,  and  shall  grant  to  all 
agents  of  the  commission  free  access  to  its  right-of-wa}',  its  property, 
and  its  accounts,  records,  and  memoranda  whenever  and  wherever 
requested  by  any  such  duly  authorized  agent,  and  every  common 
carrier  is  hereby  directed  and  required  to  cooperate  with  and  aid  the 
commission  in  the  work  of  the  valuation  of  its  property  in  such  further 
l)articulars  and  to  such  extent  as  the  commission  may  require  and  direct, 
and  all  rules  and  regulations  made  bj^  the  commission  for  the  purpose 
of  administering  the  provisions  of  this  section  and  section  twentj'  of 
this  Act  shall  have  the  full  force  and  effect  of  law.  Unless  otherwise 
ordered  by  the  commission,  with  the  reasons  therefor,  the  records 
and  data  of  the  commission  shall  be  open  to  the  inspection  and  examina- 
tion of  the  public. 

"Upon  the  completion  of  the  valuation  herein  provided  for  the 
commission  shall  thereafter  in  like  manner  keep  itself  informed  of  all 
extensions  and  improvements  or  other  changes  in  the  condition  and 
value  of  the  property  of  all  common  carriers,  and  shall  ascertain  the 
value  thereof,  and  shall  from  time  to  time,  revise  and  correct  its  valua- 
tions, showing  such  revision  and  correction  classified  and  as  a  whole 
and  separately  in  each  of  the  several  States  and  Territories  and  the 
Digfrict  of  Columbia,  which  valuations,  both  original  and  corrected, 
shall  be  tentative  valuations  and  shall  be  reported  to  Congress  at  the 
beginning  of  each  regular  session. 

"To  enable  the  commission  to  make  such  changes  and  corrections 
in  its  valuations  of  each  class  of  property,  every  common  carrier  sub- 
ject to  the  provisions  of  this  Act  shall  make  such  reports  and  furnish 
such  information  as  the  commission  may  require. 

"Whenever  the  commission  shall  have  completed  the  tentative 
valuation  of  the  property  of  any  common  carrier,  as  herein  directed, 
and  before  such  valuation  shall  become  final,  the  commission  shall 
give  notice  by  registered  letter  to  the  said  carrier,  the  Attorney  General 
of  the  United  States,  the  governor  of  any  State  in  which  the  property 
so  valued  is  located,  and  to  such  additional  parties  as  the  commission 
may  prescribe,  stating  the  valuation  placed  upon  the  several  classes 
of  property  of  said  carrier,  and  shall  allow  thirty  days  in  which  to  file 
a  protest  of  the  same  with  the  commission.  If  no  protest  is  filed  within 
thirty  days,  said  valuation  shall  become  final  as  of  the  date  thereof. 

"If  notice!  of  protest  is  filed  the  coniiiiission  shall  fix  a  time  for  hear- 


INTRODUCTION  15 

ing  the  same,  and  .shall  proceed  as  promptly  as  may  he  to  hear  and 
consider  any  matter  relative  and  material  thereto  which  may  be  pre- 
sented in  support  of  any  such  protest  so  filed  as  aforesaid.  If  after 
hearing  any  protest  of  such  tentative  valuation  under  the  provisions 
of  this  Act  the  commission  shall  be  of  the  opinion  that  its  valuation 
should  not  become  final,  it  shall  make  such  changes  as  may  be  necessary, 
and  shall  issue  an  order  making  such  corrected  tentative  valuation 
final  as  of  the  date  thereof.  All  final  valuations  by  the  commission 
and  the  classification  thereof  shall  be  published  and  shall  be  prima  facie 
evidence  of  the  value  of  the  property  in  all  proceedings  under  the  Act 
to  regulate  commerce  as  of  the  date  of  the  fixing  thereof,  and  in  all 
judicial  proceedings  for  the  enforcement  of  the  Act  approved  February 
fourth,  eighteen  hundred  and  eighty-seven,  commonly  known  as 
"the  Act  to  regulate  commerce,"  and  the  various  Acts  amendatory 
thereof,  and  in  all  judicial  proceedings  brought  to  enjoin,  set  aside, 
annul,  or  suspend,  in  whole  or  in  part,  any  order  of  the  Interstate 
Commerce  Commission. 

"If  upon  the  trial  of  any  action  involving  a  final  value  fixed  by  the 
commission,  evidence  shall  be  introduced  regarding  such  value  which 
is  found  by  the  court  to  be  different  from  that  offered  upon  the  hear- 
ing before  the  commission,  or  additional  thereto  and  substantially 
affecting  said  value,  the  court,  before  proceeding  to  render  judgment 
shall  transmit  a  copy  of  such  evidence  to  the  commission,  and  shall 
stay  further  proceedings  in  said  action  for  such  time  as  the  court 
shall  determine  from  the  date  of  such  transmission.  Upon  the  receipt 
of  such  evidence  the  commission  shall  consider  the  same  and  may 
fix  a  final  value  different  from  the  one  fixed  in  the  first  instance,  and 
may  alter,  modify,  amend  or  rescind  any  order  which  it  has  made 
involving  said  final  value,  and  shall  report  its  action  thereon  to  said 
court  within  the  time  fixed  by  the  court.  If  the  commission  shall 
alter,  modify,  or  amend  its  order,  such  altered,  modified,  or  amended 
order  shall  take  the  place  of  the  original  order  complained  of  and 
judgment  shall  be  rendered  thereon  as  though  made  by  the  commis- 
sion in  the  first  instance.  If  the  original  order  shall  not  be  rescinded 
or  changed  by  the  commission,  judgment  shall  be  rendered  upon  such 
original  order. 

"The  provisions  of  this  section  shall  apply  to  receivers  of  carriers 
and  operating  trustees.  In  case  of  failure  or  refusal  on  the  part  of 
any  carrier,  receiver,  or  trustee  to  comply  with  all  the  requirements 
of  this  section  and  in  the  manner  prescribed- by  the  commission  such 
carrier,  receiver,  or  trustee  shall  forfeit  to  the  United  States  the  sum 
of  five  hundred  dollars  for  each  such  offense  and  for  each  and  every 
day  of  the  continuance  of  such  offense,  such  forfeitures  to  be  recov- 
erable in  the  same  manner  as  other  forfeitures  provided  for  in  section 
sixteen  of  the  Act  to  regulate  commerce. 


16  VALUE  FOR  RATE-MAKING 

"That  the  district  courts  of  the  United  States  shall  have  jurisdic- 
tion, upon  the  application  of  the  Attorney  General  of  the  United 
States  at  the  request  of  the  commission,  alleging  a  failure  to  comply 
with  or  a  violation  of  any  of  the  provisions  of  this  section  bj^  any  com- 
mon carrier,  to  issue  a  wTit  or  writs  of  mandamus  commanding  such 
common  carrier  to  comply  with  the  provisions  of  this  section." 

"Approved,  March  1,  1913." 

The  first  work  of  appraisal  being  undertaken  by  the  Inter- 
state Commerce  Commission  is  that  of  all  of  the  steam  rail- 
roads of  the  United  States.  The  importance  of  this  appraisal 
may  be  judged  from  the  fact  that  it  is  estimated  the  cost  to  the 
Government  will  be  over  S20, 000,000  and  to  the  railroads 
$40,000,000  or  $50,000,000  additional.  The  mileage  of  the 
railroads  involved,  in  accordance  with  the  Interstate  Com- 
merce Commission's  report  for  the  year  ending  June  30,  1914, 
is  377,102  miles  of  track.  There  are  1,695,000  emploj'ees,  whose 
wages  and  salaries  for  the  year  mentioned  aggregated  $1,373,- 
422,000,  as  well  as  innumerable  bond  and  stockholders  owning 
$8,680,000,000  in  stock,  and  $11,567,000,000  of  bonds  or  other 
funded  debt,  who  will  be  more  or  less  directly  affected  by  the 
results  of  this  appraisal. 

The  valuation  of  the  property  of  interstate  carriers  being  under- 
taken by  the  Interstate  Commerce  Commission  calls  for  the 
ascertaining  of  the  cost  of  reproducing  new  the  property,  the  cost 
of  reproduction  less  depreciation,  the  actual  original  cost  of  con- 
struction, the  amount  of  stock  and  bonds  outstanding,  and  the 
amount  of  money  invested  in  the  property  with  the  source 
thereof. 

The  valuation  work  of  the  Interstate  Commerce  Commission 
is  often  referred  to  as  a  "physical  valuation"  and  it  is  assumed 
that  the  cost  of  reproduction  of  the  physical  property,  with  or 
without  depreciation,  will  be  taken  as  fixing  the  value  of  the 
property  of  the  common  carriers,  but  this  is  by  no  means  the  fact. 
The  United  States  Supreme  Court  has  repeatedly  held  that  the 
cost  of  reproduction  new  less  depreciation,  if  such  exists,  while 
a  very  important  element,  is  only  one  factor  entering  into  the 
final  question  of  value. 

Relatively,  it  is  not  a  difficult  thing  to  determine  the  rate  of 
return,  but  it  is  a  much  more  complicated  and  intricate  matter 
to  arrive  at  the  value  upon  which  that  rate  is  to  be  computed. 
Until  the  valuation  is  known,  it  is  impossible  to  determine  what 


INTRODUCTION  17 

income  the  propertj'  is  entitled  to  earn,  or  to  fix  the  just  tariffs 
to  be  paid  by  the  public.  It  is  a  much  more  difficult  problem  to 
establish  the  rates  of  return  for  utilities  that  compete  with  one 
another,  as  for  example  the  steam  railroads,  than  for  other  kinds 
of  public  utilities  that  are  monopolies,  such  as  water-works  or 
electric  light  properties.  Competitive  conditions  due  to  two  or 
more  railroads,  or  between  railroads  and  water  transportation 
operating  between  the  same  points,  must  largely  control  the  rates 
that  niaj^  be  charged  by  the  railroads.  The  rates  of  one  railroad 
are  of  necessity  bound  up  with  and  interdependent  upon  those  of 
its  competitor.  The  attempt  to  fix  rates  for  one  railroad  upon 
the  basis  of  a  fair  return  upon  its  fair  value,  as  might  be  done  in 
the  case  of  a  water-works  or  gas  plant,  might  result  in  the  same 
rates  being  most  advantageous  or  detrimental  to  the  competing 
railroad,  depending  upon  whether  the  investment  made  in  the 
latter  was  larger  or  less  than  that  of  the  road  whose  property 
had  been  used  in  fixing  rates.  Thus,  it  will  be  seen  that  the 
problem  of  establishing  individual  railway  rates  or  tariffs  for 
particular  classes  of  merchandise  transported  will  not  be  solved 
by  "physical  valuation"  or  probably  not  alone  by  any  valuation 
whatever,  but  the  problems  will  be  enormously  simplified,  and 
the  knowledge  from  a  reliable  source  as  to  the  value  of  the 
various  railroad  properties,  the  character  of  the  investments, 
the  state  of  efficiency,  etc.,  will  confer  a  great  benefit  upon  the 
investing  public. 

The  Valuation  Act  has  been  criticised  as  undertaking  more  than 
can  be  humanly  accomplished  sufficiently  promptly  to  make  the 
results  practically  useful.  While  there  may  be  some  justification 
for  such  criticism,  nevertheless,  great  and  undoubted  value  will 
attach  to  the  work  already  started  by  the  Interstate  Commerce 
Commission,  and  now  well  under  way,  in  that  the  work  will  give 
some  accurate  data  on  the  question  as  to  whether  the  individual 
railroads,  as  well  as  railroads  generally,  are  enormously  over- 
capitalized as  claimed  by  many,  or  whether — as  a  class — the 
railroads  may  not  have  improved  their  property  out  of  earnings, 
so  that  their  present  fair  value  closely  corresponds  to  or  even 
exceeds  their  capitalization.  It  is  recognized  by  the  Interstate 
Commerce  Commissioners  themselves  that  all  information  called 
for  in  the  Act  cannot  be  obtained ;  for  example,  the  actual,  original 
costs  of  many  of  the  railroads  are  not  now  ascertainable  for  the 


18  VALUE  FOR  RATE-MAKING 

reason  that  early  records  are  missing  and  the  knowledge  as  to 
these  original  costs  nowhere  exists. 

"Experience  indicates  that  it  will  be  possible  to  obtain  with  reasonable 
certaintj^  those  facts  called  for  with  respect  to  the  corporate  and  financial 
history  of  the  carrier,  but  that  it  will  not  be  possible  in  all  instances 
to  give  the  original  cost  'in  detail  as  to  each  piece  of  property'  as  called 
for  by  the  act."^ 

Although  definite  in  many  particulars,  the  amendment  fails  to 
define  many  of  the  terms  it  uses,  such  as  the  "cost  of  reproduc- 
tion new,"  ''depreciation"  and  "present  value,"  apparently 
leaving  it  to  the  Interstate  Commerce  Commission  to  make  its 
own  interpretation  of  these  matters,  which  will  result  in  values 
that  may  be  very  much  higher,  or  very  much  lower,  than  would 
result  if  the  interpretation  of  these  same  terms  were  made, 
respectively,  by  the  utility  owners  on  the  one  hand  or  the 
socialists  on  the  other  hand.  From  the  statement  that  the  final 
valuations  as  found  by  the  Commission  shall  be  "prima  facie  evi- 
dence of  the  value  of  the  property  in  all  proceedings  under  the 
Act  to  regulate  commerce,"  the  primary  purpose  of  the  legislative 
amendment  is  quite  commonly  believed  to  be  the  finding  of  a 
basis  upon  which  rates  may  be  determined,  but  such  is  not  stated 
to  be  the  only  purpose  of  the  valuation. 

Other  Bases. — Although  appraisals  of  property  are  more  and 
more  being  held  as  a  necessary  fact  to  be  considered  in  arriving 
at  the  fair  value  on  which  to  base  rates,  many  decisions  are  being 
made  without  such  facts  being  available.  A  recent  decision  of 
the  Public  Service  Commission  of  New  York,  First  District, 
says: 

"But  as  a  matter  of  fact,  hundreds  of  rate  cases  have  been  disposed 
of  without  appraisals.  In  some  instances  rates  have  been  lowered, 
and  in  others  the  companies  have  been  allowed  to  raise  rates.  While 
an  inventory  and  appraisal  may  be  of  assistance  in  determining  with 
great  precision  the  exact  rate  for  each  class  of  consumers,  they  are  not 
absolutely  necessary. 

The  practice  of  the  Interstate  Commerce  Commission,  throughout 
its  entire  history,  has  been  to  reduce  rates,  allow  increases  or  dismiss 
complaints  without  resorting  to  appraisals.  In  the  very  important 
Eastern  and  Western  Rate  Advance  cases,  in  the  recent  proceedings  be- 
fore the  Commission,  and  in  the  application  for  advances  now  pending, 

'  Twpiity-ninth  Animal  Report  of  tlic  Interstate  Commerce  Commission,  Dec.  1,  1915, 
I'art  I,  page  65. 


INTRODUCTION  19 

no  appraisals  have  been  made,  and  the  raih-oads  have  not  contended 
that  action  should  be  deferred  until  the  physical  valuation  of  their 
properties  has  been  completed." 

"Whether  the  record  in  this  case  is  sufficient  to  warrant  a  reduction 
in  rates  can  only  be  determined  by  an  examination  of  the  evidence, 
but  there  is  nothing  in  the  law  or  in  equity  that  would  justifj^  this 
Commission  in  taking  the  stand  that  it  will  not  alter  a  single  rate  of  the 
New  York  Edison  Company  until  an  appraisal  has  been  made." 

The  Public  Service  Commission  in  Massachusetts  has  fairly 
constantly  fixed  rates  without  having  before  it  appraisals  of  the 
properties  considered.  It  rendered  a  recent  decision  as  to  the 
Middlesex  and  Boston  Railwaj^  Company  granting  an  increase 
in  rates  of  fare  from  5  to  6  cts.  The  decision  of  Oct.  28,  1914,  says 
that  while  the  Massachusetts  statute  requires  the  Commission  to 
give  "due  regard  among  other  things  to  a  reasonable  return 
upon  the  value  of  carrier's  property,"  the  Commission  in  passing 
upon  the  claims  of  the  corporation  that  "reproduction  cost  of 
the  property  now  being  used,  less  depreciation  by  w^ear  and  tear 
and  obsoleteness,"  should  be  used  as  the  basis  of  value,  stated 
"this  theory  is  as  inexpedient  as  it  is  unjust,"  falling  back  upon 
the  amount  of  the  investment  as  the  proper  basis  upon  which 
to  fix  rates. 

Although  the  Interstate  Commerce  Commission  may  be  able 
to  formulate  principles  and  methods  properly  applicable  in  de- 
termining the  value  of  the  property  of  common  carriers,  it  by 
no  means  follows,  as  recognized  by  Commissioner  Prouty,  that 
such  values  are  the  only  considerations  to  be  used  in  fixing  rates. 
The  determination  of  proper  rates  for  railway  transportation 
is  such  an  intricate  and  extensive  matter,  the  principles  of  which 
cannot  yet  be  said  to  be  thoroughly  established,  that  it  must  be 
generally  conceded  the  value  of  the  property  alone  cannot  be 
used  for  rate-making.  In  determining  any  rate,  not  only  the 
value  of  the  plant  and  the  w^orth  of  the  service  must  be  con- 
sidered, but  also  the  further  fact  that  the  rate  must  be  low 
enough  to  secure  the  business.  Furthermore,  any  rate  based 
on  the  value  of  the  investment,  without  consideration  of  effi- 
ciency and  enterprise,  is  deficient  in  recognition  of  and  reward 
to  the  element  which  above  all  else  has  made  America  what  it  is 
to-day. 

Moreover,  in  fixing  rates  a  somewhat  more  liberal  treatment 
should  be  accorded  rapidly  developing  pul)lic  utilities,  such  as 


20  VALUE  FOR  RATE-MAKING 

those  engaged  in  rendering  electric  service,  compared  with  older 
and  more  stable  utilities,  such  as  water  and  perhaps  gas  or 
seasoned  steam  railroad  systems.  As  a  rule  these  latter  have 
passed  through  their  formative  periods  and  now  present  fewer 
problems,  in  connection  with  rate-fixing,  than  those  which  by 
reason  of  the  inability  to  store  their  product  and  because  of  their 
recent  rapid  growth  and  necessity  for  frequent  discarding  of 
l)lant  and  apparatus,  have  created  new  and  less  stable  economic 
business  problems. 

While  existing  net  earnings  cannot  be  taken  as  fixing  the  value 
of  any  public  utility  property,  the  value  of  that  property  will 
ultimately  be  determined  by  the  net  earnings  allowed  in  any  rate 
case.  After  the  various  cost  elements  are  obtained,  such  as  the 
investment  cost,  the  cost  of  reproduction,  the  cost  of  reproduc- 
tion less  depreciation,  and  a  tentative  value  found  therefrom 
upon  which  a  tentative  rate  may  be  fixed,  the  real  value  of  the 
property  will  result  from  the  actual  net  earnings.  The  effect  of 
the  net  earnings  allowed  must  be  considered  and  their  result 
weighed  as  a  factor  in  ascertaining  the  fair  value  to  be  allowed. 
The  value  to  be  established  is  the  result  of  a  consideration  of  the 
valuation  of  the  property  itself  and  the  rate  allowed  thereon. 
Th(^  fixing  of  a  value  is  of  itself  of  no  avail  unless  the  return 
thereon  is  sufficient  to  satisfy  the  requirements  of  investors  in 
such  enterprises  and  to  invite  free  capital  to  invest;  too  low  a 
return  will  depreciate  a  value  however  established.  A  normal 
or  liberal  return  will  stabilize  value  and  invite  investment.  It  is 
useless  to  argue  that  either  cost  or  investment  is  market  value,  as 
such  latter  value  is  only  determined  by  the  net  earnings  actually 
or  prospectively  obtained,  regardless  of  what  may  be  determined 
as  the  fair  value  after  an  appraisal  or  estimated  as  profits  by 
a  regulating  body.  Regardless  of  the  methods  used  in  ascertain- 
ing the  so-called  value  of  physical  property,  with  or  without 
its  intangil)le  values,  the  ultimate,  real  value  will  be  determined 
by  the  net  earnings  from  the  proi)erty  and  the  cost  of  money  in 
open  market. 


CHAPTEK   II 
DEFINITIONS 

Explanatory. — Because  of  the  present  confused  use  of  words 
and  phrases  in  connection  with  rate-making  and  valuation,  some 
brief  definition  of  the  terms  used  by  the  author  is  necessary. 

In  too  many  instances  the  English  language  uses  the  same  word 
for  different  meanings.  In  valuation  work  the  call  for  words 
to  define  new  meanings,  or  confused  and  indefinite  ideas  as 
to  what  is  intended,  has  resulted  in  the  use  of  the  same  word  to 
mean  different  things. 

Value. — Academically  the  word  "value"  relates  to  "barter 
and  exchange."  One  of  the  principal  causes  of  demand — there 
are  several — is  usefulness  or  utility;  consequently  "value"  may 
properly  be  used  to  measure  utility.  In  valuation  work,  as  a 
rule,  loss  of  utility  results  in  loss  of  value;  maximum  utility 
determines  maximum  value.  The  ratio  of  existing  to  possible 
utility,  measures  by  the  same  ratio,  when  applied  to  cost  as 
used  in  its  largest  sense,  the  existing  value,  in  dollars,  of  the 
commodity  or  service.  If  the  term  related  exclusively  to  barter 
and  sale,  only  second-hand  or  scrap  values  would  be  considered, 
which  is  not  the  basis  on  which  any  appraisal  has  been  or  is  })eing 
made  for  determining  fair  values  of  the  "used  and  useful" 
property  belonging  to  an  operating  organization. 

Physical  or  Structural  Value. — As  the  term  indicates,  physical 
value  relates  to  material  things  or  substances,  the  property  which 
can  be  "seen  and  felt."  It  includes,  primarily,  "those  things 
which  are  visible  and  tangible,  capable  of  being  inventoried,"  but 
secondarily,  certain  non-physical  charges  "which  are  an  insepar- 
able part  of  the  cost  of  construction  but  which  do  not  appear  in 
the  inventory  of  the  completed  property." 

These  secondary  costs,  which  are  usually  included  as  a  part  of 
the  physical  property,  either  directly  in  the  unit  prices  or  added 
afterward  in  the  form  of  percentages,  are  expenditures  for  such 
items  as: 

1.  Engineers'  and  architects'  fees,  including  cost  of  design  and 
testing  all  construction  and  equipment,  etc. 

21 


22  VALUE  FOR  RATE-MAKING 

2.  Administration  expenses  chargeable  to  construction,  in- 
cluding superintendence,  inspection,  accounting,  salaries  of 
officers  and  clerks,  consents  of  authorities  and  property  owners 
for  temporary  work  or  use,  legal  expenses,  rent,  printing,  store- 
room expenses,  etc. 

3.  Provision  for  various  incidentals  and  contingencies,  incom- 
plete inventories,  unforeseen  requirements,  etc.,  which  practical 
experience  has  shown  to  be  necessary. 

Scrap  or  Salvage  Value. — All  physical  propertj^  has  a  certain 
scrap  or  junk  value,  a  "barter  and  sale"  minimum  basis  beyond 
which  there  is  no  depreciation,  hence  physical  property  can  only 
deteriorate  until  it  reaches  its  scrap  value.  If  a  property  consist- 
ing of  its  several  elements  is  usable  not  as  junk  but  as  serviceable 
property  elsewhere,  a  higher  price  than  scrap  value  is  obtainable, 
and  this  worth  has  been  characterized  as  "salvage  value." 

Wearing  Value. — If  from  the  cost — taken  on  whatever  basis  is 
determined  to  be  the  correct  one — there  is  subtracted  "scrap" 
or  "salvage"  value  of  given  physical  property,  the  remainder 
is  a  value  known  as  "wearing  value"  (sometimes  improperly 
called  service  value). 

Service  Value. — Physical  property,  honestly  and  inteUigently 
purchased  with  a  view  to  its  suitableness  for  the  service  intended, 
aside  from  some  hidden  defect  or  untoward  accident,  generally 
maintains  its  original  utility,  and  hence  its  value,  for  the  purpose 
of  use,  practically  throughout  its  life,  except  for  such  deteriora- 
tion as  results  from  wear  and  tear  or  deferred  maintenance. 
The  life  of  the  property  may  expire  normally  through  age  or 
prematurely  through  accident,  inadequacy  or  obsolescence,  but 
these  latter  classes  of  depreciation  develop  quickly,  so  that  for 
the  larger  part  of  the  time  used,  the  service  value  of  property  will 
approximate  the  cost. 

Present  Value. — The  term  refers  to  the  fair  value  of  the 
proeprty  at  the  period  being  considered.  Though  not  always 
so,  present  value  usually  means  the  original  cost  or  cost  to  repro- 
duce, reduced  by  the  amount  of  either  absolute  observed  deprecia- 
tion or  theoretical  computed  depreciation,  or  sometimes  the  sum 
of  both  of  these  items. 

Original  Cost. — Original  cost  may  be  taken  to  mean  the  sum  of 
all  actual  expenditures  made  to  date  on  a  given  property — pre- 
ferably termed  investment  cost — but  more  usually  it  refers  to  the 
actual  cost  of  the  present  existing  evidenced  items  of  property. 


DEFINITIONS  Zi 

Cost  to  Reproduce  New. — Roprodiictioii  cost  as  defiiicHl  by 
the  courts  refers  to  an  assumed  cost,  based  on  the  estimated 
expenditures  necessary  for  reprochicing  the  property  new  on  the 
basis  of  prices  current  at  the  time  of  estimate — prices  that 
fluctuate  considerably  are  averaged  for  five  or  more  years  pre- 
ceding the  date  of  the  appraisal,  or  adjusted  upon  some  other 
fair  basis — and  is  made  up  to  include  everything  that  can  be 
inventoried  regardless  of  original  cost,  age,  service  value  or 
present  condition  as  affected  by  depreciation. 

Development  Expenses  or  Overhead  Charges. — In  connection 
with  the  establishment  of  any  utility  property,  certain  expendi- 
tures are  necessary  for  developing  and  completing  the  physical 
property,  aside  from  the  cost  of  structures.  These  are  in  addition 
to  those  other  expenses  of  developing  the  business  and  producing 
an  income.  The  former  non-physical  values  may  be  classed 
as  "Development  Expenses"  or  "Overhead  Charges,"  and  the 
latter  as  "Going  Value,"  but  both  items  relate  to  costs — in- 
tangible because  they  cannot  be  seen  and  handled — and  are  apart 
from  and  in  addition  to  those  expenditures  relating  to  the  cost 
of  the  physical  plant.  As  a  class,  those  expenses  incurred  in 
connection  with  completing  the  physical  property  are  frequently 
referred  to  as  "overhead  charges,"  sometimes  as  "intangible 
expenses,"  but  as  they  refer  largely  to  the  outlay  necessary  in 
getting  the  physical  plant  running,  the  author  prefers  the  quite 
commonly  used  term  "Development  Expenses"  which  generally 
cover  most  or  all  of  the  following  expenditures: 

1.  Legal  and  other  expenses  of  preliminary  promotion,  in- 
corporation and  organization,  procuring  consents  of  property 
owners,  condemnation  proceedings,  obtaining  franchises,  consents 
and  certificates  from  Public  Service  Corporations  and  other 
public  bodies,  sometimes  title  examination  and  insurance. 

2.  Technical  expenses  in  connection  with  preUminary  work, 
surveys,  expert  estimates,  etc. 

3.  Interest  on  capital  and  bond  issues,  wages  of  superintend- 
ence and  administration  not  chargeable  to  construction  ordinarily 
necessary  in  connection  with  putting  a  property  in  going. order, 
and  also  sometimes,  although  not  properly  so,  the  deficiency  in 
operating  expenses,  taxes  and  fair  return  until  the  property  is 
put  on  a  paying  basis. 

4.  Taxes  of  various  amounts  including  corporation  tax, 
mortgage  tax,   real  estate  tax,   personal  property  tax,   capital 


24  VALUE  FOR  RATE-MAKING 

and  State  tax,  franchise  tax,  etc.,  which  must  be  provided  and 
paid  before  the  complete  cost  of  a  property  is  obtained. 

5.  Discounts  on  securities,  brokerage  or  other  customary 
and  necessary  expenditures  in  connection  with  financing  a  utility 
and  marketing  its  securities. 

6.  Reasonable  promotion  profit,  possibly  also  some  compensa- 
tion for  risk  of  capital. 

7.  Working  capital. 

Good-will. — A  monopoly,  as  is  generally  admitted,  has  no 
good- will  which  can  be  evaluated,  and  the  courts  have  sustained 
this  view.  Good-will  usually  results  where  competition  exists, 
and  the  tendency  of  the  times  is  to  make  no  allowance  for  this 
element  in  a  public  utility  valuation,  it  being  considered  that 
good-will  belongs  rather  to  industrial  enterprises  where  its  value 
is  determined  by  the  profitableness  of  the  business,  namely, 
"capitalizing  the  net  income." 

Going  Value. — "Going  Value,"  "Going  Concern  Value," 
and  "Going  Concern"  are  several  terms  that  have  been  used  to 
refer  to  an  intangible  value  beyond  that  of  the  physical  plant 
attaching  to  a  live,  active -operating  and  revenue-producing 
property.  The  value  in  question  is  generally  held  to  relate  to, 
and  is  evaluated  from,  a  consideration  of  revenue  and  earnings. 

Depreciation. — Webster  defines  "depreciation"  as  the  "act 
or  state  of  lessening  the  worth  of."  The  Century  Dictionary 
says  it  is  "a  fall  in  value;  reduction  of  worth."  In  appraisal 
work  it  is  used  broadly  to  mean  a  reduction  in  utility  value 
expressed  as  a  percentage  but  more  usually  in  dollars,  due  to 
any  deterioration  in  physical  plant  by  reason  of: 

(a)  Normal  wear  and  tear. 

(6)  Age  or  physical  decay. 

(c)  Inadequacy. 

(d)  Obsolescence. 

(e)  Deferred  maintenance. 

The  term  depreciation,  always  used  in  connection  with  a 
reduction  of  value,  has,  however,  four  distinct  and  separate 
shades  of  meaning,  so  that  the  term  must  be  qualified  when 
used  in  order  to  distinguish  which  one  of  the  following  meanings 
is  intended: 

First. — The  annual  amount,  expressed  as  a  percentage  or  in 
dollars,  that  should  be  laid  aside  to  renew  or  replace  the  article  in 
question  at  the  timo  of  its  abandonment. 


DEFINITIONS  25 

Second. — The  annual  amount,  expressed  as  a  percentage  or  in 
dollars,  that  should  be  laid  aside  to  renew  or  replace  the  article 
in  question  at  the  time  of  its  abandonment,  plus  the  annual 
expense  of  maintenance  and  repair  expended  in  removing  such 
part  of  depreciation  as  is  practicable  and  good  economy. 

Third. — The  total  amount — usually  that  estimated  as  neces- 
sary to  be  expended  to  put  the  physical  property  in  perfect  operat- 
ing condition — determined  by  the  inspection  and  observation  of 
an  experienced  engineer,  expressed  in  a  percentage  or  in  dollars, 
which  must  be  deducted  from  the  "original  cost"  or  the  "cost 
to  reproduce  new,"  in  order  to  determine  the  absolute,  actual, 
present  value. 

Fourth. — The  total  amount — it  may  be  the  sum  of  several  years 
of  depreciation — computed  from  "expectancy  of  life"  tables, 
more  or  less  authoritative,  expressed  in  a  percentage  or  in  dollars, 
that  must  be  deducted  from  the  "original  cost"  or  the  "cost  to 
reproduce  new, "  in  order  to  obtain  the  theoretical,  present,  de- 
preciated value.  This  value  may  be  increased  or  reduced  by  the 
condition  of  the  property,  as  determined  from  inspection. 

Classes  of  Depreciation. — The  subject  of  Depreciation,  from 
an  engineering — not  an  accountant's — standpoint,  practically 
divides  itself  into  several  classes,  as  follows: 

(a)  Wear  and  Tear,  or  Maintenance. — This  includes  such  de- 
preciation as  may  ordinarily  be  removed  or  offset  by  proper  ex- 
penditures at  such  time  as  the  worn-out  parts  may  be  economic- 
ally replaced.  Few  parts  of  physical  property  in  use  ever  become 
completely  worn  out;  after  a  certain  amount  of  wear,  a  point  is 
reached  at  which  good  engineering  requires  their  replacement; 
they  may  be  still  further  used,  but  only  at  the  cost  of  economy  or 
safety. 

(6)  Age,  Physical  Decay  or  Decrepitude. — Depreciation  of 
this  sort  is  due  to  the  aging  of  apparatus  that  usually  has  a 
life  extending  over  a  period  of  years.  Property  that  is  short- 
lived usually  passes  away  through  "wear  and  tear."  In  many 
instances,  age  depreciation  will  be  the  same  whether  the  apparatus 
is  used  or  unused,  i.e.,  a  boiler  or  an  insulated  wire  will  deteriorate 
through  the  action  of  the  elements  practically  as  rapidly  when 
standing  idle  as  when  in  continued  service. 

(c)  Inadequacy  or  Supersession. — This  class  of  depreciation 
arises  from  increased  demands  of  or  opportunity  for  service  so  as 
to  render  the  property  in  use  inconvenient  or  uneconomical  for 


20  VALUE  FOR  RATE-MAKING 

continuance  of  operation,   although  in   every   way   capable  of 
performing  the  service  for  which  it  was  installed. 

(d)  Obsolescence. — Obsolescence  means  the  depreciation  of  prop- 
erty through  the  development  of  something  newer  and  either 
more  economical  or  more  of  a  fad.  Like  inadequacy,  it  may  ne- 
cessitate the  abandonment  of  property  long  before  it  is  worn  out 
and  in  many  cases,  arises  largely  from  demands  of  the  public. 

(e)  Deferred  Maintenance. — The  several  classes  of  depreciation 
hereinbefore  referred  to  assume  that  the  propert}^  will  be  kept  in 
good  operating  condition  and  efficiency.  If  the  condition  of  the 
property  is  permitted  to  lapse  beyond  that  of  safety  or  economy 
in  operation  there  results  a  condition  due  to  neglect  of  proper 
maintenance  and  regular  repairs,  a  condition  known  as  "Deferred 
Maintenance." 


CHAPTER  III 
FUNDAMENTALS  IN  VALUATION 

Before  and  after  Regulation  Begins. — In  questions  relating 
to  rate  regulation  of  public  utilities,  the  determination  of  value 
is  fundamental.  Yet  it  is  with  regard  to  the  definition  of  value 
that  the  chief  controversy  and  difference  of  opinion  exists.  The 
general  principle  that  public  authorities  have  the  inherent 
right  to  regulate  utilities  is  now  generally  accepted.  The  present 
rate  of  return  to  be  allowed  upon  the  value  of  the  property  may 
generally  be  agreed  upon  within  reasonable  limits.  The 
allowance  for  operating  expenses  is  not  usually  a  subject  of  con- 
troversy. The  fact  that  something  must  be  set  aside  to  cover 
depreciation  is  generally  conceded,  and  the  amount  thereof  can 
usually  be  determined  fairly  accurately.  But  the  value  of  the 
property,  the  amount  of  which  so  largely  affects  the  total  revenue 
to  be  allowed  in  rate  fixing,  will  be  found  to  vary  widely,  depend- 
ing upon  the  premises  used  in  arriving  at  the  value. 

Until  within  the  last  few  years  net  earnings  have  been  considered 
a  fair  and  safe  basis  on  which  to  predicate  the  value  of  a  given 
property.  Either  market  value  or  par  value  of  stocks  and  bonds 
outstanding  for  a  given  property  have,  in  many  instances,  been 
taken  as  the  value  of  the  property  itself.  Both  these  bases  have 
been  recognized  and  approved  by  the  lower  and  higher  courts  as 
authoritative  evidences  which  must  be  considered  in  fixing  the  value 
of  any  given  property,  but  with  the  development  and  progress  of 
the  present  era  of  public  regulation,  less  weight  and  considera- 
tion have  been  given  to  net  earnings  and  capitalization  in  fixing 
upon  the  value  of  utility  property  to  be  used  as  the  fair  basis 
upon  which  to  predicate  rates.  The  reasons  for  this  view 
are  just  and  fairly  conclusive.  The  present  day  tendency  is  to 
determine  value  primarily  either  from  the  amount  of  the  invest- 
ment which  can  be  shown  to  have  been  fairly,  honestly  and  use- 
fully made,  or  from  the  estimated  cost  of  reproducing  the 
existing  property,  either  with  or  without  deducting  depreciation. 
Although  each  of  these  two  methods  of  determining  value  has 
many  supporters  and  adherents,  too  often  the  controlling   in- 

27 


28  VALUE  FOR  RATE-MAKING 

fluence  in  the  adherence  to  either  principle  is  some  element  of 
self-interest.  As  a  matter  of  fact,  both  methods  of  arriving  at 
value,  so  apparently  diverse,  are  being  used,  and  if  properly- 
applied  and  with  a  view  to  doing  justice  in  the  premises,  both 
may  be  approved.  The  principal  differences  of  opinion  that  exist, 
then,  between  the  various  authorities  attempting  to  establish 
proper  methods  of  valuation  and  rate-making,  relate  to  proper 
interpretation  of  the  meaning  and  application  of  value  new,  and 
the  proper  use  of  estimates  of  depreciation.  The  reason  for 
these  differences  of  opinion  are  due  primarily  to  the  failure  to 
distinguish  between : 

(a)  Principles  that  should  be  applied  in  reference  to  long- 
established  and  existing  utilities. 

(6)  Principles  that  should  be  applied  with  reference  to  utilities 
newly  created  under  commission  regulation,  or  that  may  be  created 
in  the  future. 

The  serious  question  at  present  is,  not  what  possible  theories 
and  methods  may  be  developed  for  ascertaining  the  value  and 
determining  the  depreciation  of  utilities  yet  to  be  created,  but 
rather  what  methods  of  valuation  shall  be  followed  in  appraising 
the  many  existing  and  long-established  utilities. 

Probably  everyone  would  agree  that  any  specific  rulings  may 
be  correct,  provided  they  are  applied  only  to  newly  created 
corporations  in  which  investors  placed  their  money  after  due 
notice  as  to  the  methods  that  would  be  applied  and  the  returns 
which  would  be  securable  therefrom,  but  it  is  absolutely  unfair, 
and  probably  illegal,  to  attempt  to  saddle  untried,  theoretical 
methods  upon  innocent  owners  who  invested  their  money  under 
conditions  and  upon  assumptions  entirely  different  from  those 
now  proposed. 

The  fact  that  new  and  unaccepted  conditions  cannot  after- 
ward be  imposed  upon  a  utility  which  has  made  an  investment 
upon  definite  premises,  is  not  only  in  line  with  court  rulings  but 
even  past  misdecnls  have  been  excluded  from  considcsration  in 
fixing  flic  l)asis  of  present  valuation. 

"But  in  this  process  of  condemnation  of  property,  the  owner  is  not 
to  be  punished  for  past  misuse  of  it."^ 

Ttie  unfairness  and  illegality  of  attempting  to  apply  ex  post 
facto  rulings  to  utility  regulation  is  ably  stated  by  Commissioner 

'  Kennebec  Water  District  vs.  City  of  Waterville  Et  al.,  97  Me.,  18o. 


FUNDAMENTALS  IN  VALUATION  2<) 

Eshleman,  Ex-President  of  the  Railroad  Commission  of  California, 
in  dissenting  from  an  opinion  written  by  his  fellow  Commissioner, 
Mr.  Thelen,  in  the  following  language: 

"While  I  do  not  for  a  moment  question  the  power  of  any  govern- 
mental agency  to  impose  conditions  in  advance  on  any  business  requir- 
ing governmental  sanction  to  be  carried  on,  on  the  acceptance  of  which 
conditions  may  depend  the  right  of  any  person  or  corporation  to  conduct 
such  business,  yet  I  do  not  conclude  that  this  power  to  impose  condi- 
tions in  advance  necessarily  implies  the  power  to  impose  added  condi- 
tions on  a  business  already  operating  under  governmental  sanction 
after  such  business  has  assumed  all  the  obligations  required  by  law 
to  be  assumed  at  the  time  of  the  initiation  of  its  enterprise.  For 
example,  I  am  very  sure  that  a  condition  in  a  franchise  to  the  effect 
that  never  shall  the  agency  accepting  such  franchise  capitalize  it  or 
claim  value  for  it  at  more  than  its  cost,  or  any  value  at  all  for  that 
matter,  would  be  good  and  enforceable  against  the  agency  accepting 
such  franchise.  Likewise  do  I  believe  that  a  condition  in  a  franchise 
requiring  the  one  accepting  the  same  to  account  as  agent  to  the  authority 
granting  such  franchise  would  be  equally  valid.  It  would  have  sim- 
pUfied  matters  immeasurably,  both  for  pubUc  utihties  and  public 
authority  had  such  public  authority  been  far  seeing  enough  to  have 
attached  conditions  to  all  gifts,  such  as  I  here  suggest,  but  failing  to 
do  so  in  advance,  I  very  much  doubt  the  power  of  the  State  to  impose 
them  now.  I,  of  course,  should  not  be  understood  here  as  urging  that 
the  State  lacks  all  power  to  impose  conditions  on  corporations  or 
persons  engaged  in  any  kind  of  business  at  a  subsequent  stage  of  the 
existence  of  such  business,  which  it  did  not  impose  at  the  initial  period. 
All  agencies,  of  whatsoever  character,  embark  on  their  enterprises  in 
full  legal  contemplation  of  the  power  of  the  State,  should  the  need 
arise,  to  exercise  every  governmental  function  which  the  State  may  at 
any  time  exercise  and  the  subsequent  necessity  for  the  government 
to  act  in  any  particular  way  it  may  be  called  upon  under  its  power 
to  act,  is  as  a  condition  subsequent  accepted  by  all  who  live  under 
government.  The  general  authority  of  a  State  of  this  Union,  under  its 
police  power,  or  the  Federal  Government  under  any  of  its  delegated 
powers  to  impose  conditions  upon  a  busness  at  any  stage  of  its  existence, 
is  not  that  to  which  I  here  refer.  All  readily  agree  that  such  authority 
is  a  general  condition  imposed  at  the  beginning  and  always  existing. 
But  unless  referable  to  the  police  or  other  general  power  of  the  State 
of  California,  this  State  has  no  power  to  impose  conditions  on  any 
enterprise  which  has  lawfully  acquired  its  property  and  initiated  its 
business  except  as  a  condition  precedent  imposed  upon  such  enterprise 
in  the  beginning,  unless  the  owners  of  such  enterprise  voluntarily 
accept  such  condition.     In  other  words,  the  State  has  the  right  to  say 


30  VALUE  FOR  RATE-MAKING 

in  advance  upon  what  conditions  a  utility  enterprise  may  initiate  and 
conduct  its  business  and  may,  as  a  part  of  the  contract,  impose  con- 
ditions on  the  acceptance  of  which  the  agency  so  accepting  becomes 
bound  thereby,  but  faihng  to  do  so  in  advance  the  only  conditions  that 
may  be  imposed  thereafter  are  those  conditions  authorized  and  justified 
by  the  police  power.  It  is  my  belief,  therefore,  that  the  failure  of  the 
State  to  impose  conditions  in  advance  divests  it  thereafter  of  the  power 
of  imposing  such  conditions  unless  the  police  power  authorizes  such 
imposition. 

I  feel  it  best  to  meet  this  squarely  rather  than  delude  ourselves  longer 
in  the  belief  that  we  as  a  people  may  continue  safely  to  divest  ourselves 
of  things  of  value  with  no  return  until  all  the  common  store  is  exhausted, 
in  the  belief  that  our  mistaken  generosity  will  be  reciprocated  by  those 
accepting  our  gifts.  They  will  not  reciprocate,  and  under  the  law 
they  may  not  be  forced  to  give  back  that  which  we  have  so  foolishly 
and  bounteously  granted."^ 

There  is  a  general  tendency  to  ignore  the  fact  that  newly  organ- 
ized utilities,  originated  under  present-day  regulation  cannot  be 
treated  the  same  as  long-established  utilities  which  have  been 
created  and  operated  without  much  restriction  as  to  their  tariffs 
or  rates  of  return.  To  undertake  to  establish  an  intelligent  and 
fair  basis  for  fixing  rates,  there  must  be  drawn  a  sharp  line  of 
demarcation  between  those  principles  that  may  be  applied  to  a 
corporation  existing  and  long-established,  or  one  which  may  be 
originated,  under  newly  inaugurated,  public-service  regulation. 
This  does  not  assail  or  refute  the  principle  that  in  both  cases 
present  value  is  to  be  determined,  but  it  does  recognize  the  fact 
that  methods  of  getting  at  the  present  value  may  properly  differ. 

Where  utility  property  has  been  constructed  and  put  into 
operation  before  the  creation  of  regulating  commissions,  the 
investors,  with  the  consent  of  municipal,  state  or  federal  authori- 
ties and  the  sanction  of  the  public  at  large,  were  allowed  to  do 
certain  things  which  are  no  longer  permitted  under  utility  regula- 
tion. For  example,  the  utilities  have  generally  been  allowed  to 
take  as  earnings  and  use,  as  the  property  of  the  owners,  all 
revenue  above  that  required,  in  the  opinion  of  honest  directors, 
for  paying  operating  expenses,  interest  and  taxes  or  the  accunm- 
lation  of  surplus.  Since  the  origin  of  public  regulation,  due  in 
some  measure  to  the  fact  that  certain  corporations,  through 
their    directors,    have   used    poor   judgment    or   violated    their 

'  Decision  of  the  Railroad  Commission  of  California,  Town  of  Antiodi  vs.  Pacific  Gas  and 
Electric  Compiiny,  Cuh<!  No.  400;  Decision  .N'o.   10.")5;  July  6,   1914. 


FUNDAMENTALS  IN  VALUATION  31 

fiduciary  relations  or  have  rendered  abnormally  i)o()r  scivicc, 
there  has  resulted  a  demand  that  the  corporations  not  only 
maintain  their  properties  in  first-class  operating  condition,  hut 
in  addition  accumulate  reserve  funds  which  shall  be  held  in 
cash,  property  or  its  practical  equivalent.  This  innovation 
and  the  setting  up  of  new  rules  by  public  service  commissions 
or  other  authorities  may  not  be  questioned  and  is  eminently 
fair  as  to  the  application  of  future  revenue,  provided  the  cor- 
porations are  permitted  to  make  earning  sufficient  to  carry  out 
such  program,  but  the  attempt  to  confiscate  property  by  the 
application  of  such  rules  to  the  past  is  not  fair  and  cannot  be 
sustained. 

This  is  by  no  means  claiming  that  because  owners  have,  in  the 
past,  taken  all  earnings  and  made  no  provisions  for  renewals  and 
replacements,  the  entire  cost  of  such  renewals  and  replacements 
must  necessarily  be  paid  for  by  the  public  in  addition  to  a  fair 
return  on  the  value  of  the  property.  If,  as  is  the  case  with  many 
existing  utilities,  the  earnings  in  the  past  have  been  insufficient 
to  pay  more  than  operating  expenses  and  a  fair  return  on  the  full 
value  of  the  property,  then  the  public  not  heretofore  having 
provided  sufficient  to  cover  anticipated  depreciation,  must  have 
the  cost  of  all  future  renewals  and  replacements  included  in  future 
tariffs.  On  the  other  hand,  if  the  public  has  been  paying  suffi- 
cient to  provide  both  fair  return  and  an  allowance  for  depreciation, 
both  of  which  amounts  have  been  taken  by  the  owner  as  profits, 
that  portion  of  the  total  taken,  which  is  applicable  to  the 
depreciation  account,  must  be  provided  by  the  owner  at  the 
time  renewals  and  replacements  are  necessary,  either  by  fore- 
going all  or  part  of  his  future  return  or  providing  cash  from  out- 
side sources  without  increasing  the  investment  or  property  values 
upon  which  rates  are  fixed.  In  any  number  of  cases,  stock- 
holders are  doing  this  very  thing,  viz.:  foregoing  dividends  to 
provide  renewals,  and  such  method  of  maintaining  property 
in  no  way  controls  the  basis  of  rates.  Where  a  corporation  is 
created  and  the  money  of  the  owners  is  invested,  after  notice, 
under  conditions  prescribed  in  advance  by  regulating  bodies, 
there  can  be  no  fair  or  honest  objection  to  the  insistence  upon 
accumulation  of  depreciation  funds  out  of  revenue  and  the  use 
of  such  funds  in  any  reasonable  way,  but  they  cannot  necessarily 
be  used  as  a  measure  of  the  present  value  of  the  property  on 
which  rates  are  to  be  fixed. 


32  VALUE  FOR  RATE-MAKING 

With  respect  to  corporations  that  have  been  in  existence  for  a 
considerable  period  of  time  without  commission  regulation,  and 
have  been  following  certain  generally  accepted  principles  with 
the  acquiescence  more  or  less  definite,  of  public  authorities,  it  is 
manifestly  unjust  to  determine  value  for  rate-fixing  purposes  by 
deducting  from  the  cost  of  reproduction  new,  a  computed  but  not 
accumulated  amount  of  theoretical  depreciation,  which  it  is  as- 
sumed should  have  been  amassed  in  a  so-called  reserve  fund. 
Such  method  after  notice  by  the  regulating  body,  may  possibly, 
under  some  circumstances,  be  reasonable  when  applied  to  certain 
newly  organized  corporations,  but  they  are  unfair  as  applied  to 
most  existing  corporations.  That  the  same  rules  may  not  fairly 
be  applied  equally  to  all  utility  corporations,  thus  so  differently 
originated,  has  been  recognized  by  the  Railroad  Commission  of 
California. 

"We  find  a  condition  brought  about  by  proceedings  which  took 
place  before  the  Public  Utilities  Act  went  into  effect  which  probably 
we  would  not  have  authorized  in  their  present  form.  The  applicant 
desires  now  to  go  forward  from  this  point  and  to  take  other  steps  which 
in  our  opinion,  standing  alone,  considerations  of  public  policy  would 
not  prevent."     (Page  ISS^.) 

"Heretofore,  in  dealing  with  its  financial  affairs,  we  have  imposed 
certain  conditions  with  a  view  to  the  ultimate  consummation  of  the 
objects  for  which  the  company  was  formed,  but  have  been  more  lenient 
in  this  regard  than  we  would  be  if  the  enterprise  were  one  which  had  its 
inception  after  the  passage  of  the  Public  Utilities  Act."     (Page  665 ^) 

Public  utility  properties  can  be  operated  satisfactorily  to  the 
owners,  and  can  be  made  to  render  reasonable  and  adequate 
service  to  the  public,  under  either  of  the  methods  of  regulation  and 
control  referred  to,  namely: 

(a)  An  assured  return,  commensurate  with  the  nature  of  the 
guarantee,  upon  the  investment  made  by  the  owners. 

(b)  A  variable  return,  commensurate  with  the  risks  of  the 
business,  upon  the  present  fair  value  of  the  property  used. 

The  present  trend  of  public  service  commission  rulings  is  toward 
the  former,  that  is,  the  investment  cost;  nevertheless,  such  basis  is 
not  sanctioned  by  the  United  States  courts.  The  United  States 
Supreme  Court,  in  a  long  line  of  decisions,  has  adhered  to  present 
value  and  not  original  cost  as  the  proper  basis  upon  which  to  fix 
rates.     This  divergence  of  view  and  fundamental  difference  in  the 

'  Ucporta  Uuilroad  f'oiiiniission  of  California,  Jan.   1,  Ittll,  to  Dfo.  .'{1,  1912. 


FUNDAMENTALS,  IN  VALUATION  33 

rulings  and  decisions  of  these  two  classes  of  authorities  must  be 
kept  clearly  in  mind  in  all  valuation  work,  particularly  where  the 
values  determined  are  to  be  passed  on  by  the  courts. 

To  arrive  at  impartial  fairness  in  regulation,  it  must  be  rec(jg- 
nized  that  the  public  utility  companies  are  not  starting  simul- 
taneously with  utility  regulating  commissions.  Regulation 
enters  the  field  with  the  utility  corporations  already  in  full  swing. 
In  well-established,  going  utilities  speculative  profits  are  not 
necessary  for  the  future  but  have  been  in  the  past.  Pul)lic 
regulation  in  fixing  the  allowable  value  is  apt  to  consider  only 
the  present  and  forget  the  speculative  element.  The  fact  that  a 
different  status  exists  as  to  corporations  ))efore  and  after  public 
regulation  begins  is  clearly  recognized  by  the  Interstate  Com- 
merce Commission. 

"  *  *  *  if  any  government  tribunal  is  to  do  justice  between  the  railway 
and  the  public,  if  it  is  to  feel  any  confidence  in  the  correctness  of  these 
conclusions,  this  supervision  must  be  continuous  and  not  spasmodic. 
There  must  be  some  point  of  departure  and  from  that  point  knowledge  of 
the  government  must  be  accurate  and  complete.  After  earnings  have 
been  'capitalized'  and  benefits  have  been  'completed,'  when  the  various 
independent  organizations  have  been  perfected,  it  is  impossible  either 
to  know  or  to  undo."' 

The  point  to  be  made  clear  is  that  no  ex  post  facto  rulings 
should  be  attempted  or  countenanced  by  commissions  or  other 
authorities  simply  because,  for  example,  a  corporation  has  no  de- 
preciation reserve  fund  in  hand.  Who  shall  say  that,  because 
utilities  had  not  accumulated  reserve  funds  before  the  present 
character  of  public  regulation  was  instituted,  therefore,  the  cor- 
porations shall  now  be  deprived  of  a  part  of  the  value  of  their 
property.  In  determining  rates  where  the  public  and  corporations 
have  consented  to  the  existence  of  a  certain  thing  in  the  past  that 
is  not  legally  or  criminally  wrong,  and  about  which  there  still 
exists  honest  differences  of  opinion,  it  is  not  fair  or  right,  in  mak- 
ing rulings  for  the  future,  to  attempt  to  apply  such  rulings  to  the 
past  at  the  sacrifice  of  investment  or  the  jeopardy  of  income. 
It  is  on  this  point — the  difference  between  a  corporation  already 
in  existence  and  one  originated  under  new  laws — that  the  mis- 
takes have  been  made  in  the  rulings  of  commissioners,  very 
many  of  whom,  inexperienced  in  utility  corporation  affairs,  have 

'  Decision  of  the  Interstate  Commerce  Commission,  Spokane  vs.  Northern  Pacific  Uwy. 
Co.  15  I.  C.  C.  R.  416. 


34  VALUE  FOR  RATE-MAKING 

attempted  to  apply  theoretically  perfected  methods  which  are 
largely  the  result  of  devolopm(>iit  and  experience.  It  is  the  old 
truth,  that  the  same  medicine  will  make  some  men  well  and  others 
ill. 

Competition. — In  attempting  to  establish  principles,  it  must  be 
recognized  that  while  there  are  certain  general  applications  that 
relate  to  all  utilities,  there  are  special  considerations  which 
apply  to  particular  classes  of  utilities  and  which  do  not  hold  for 
other  classes.  A  utility  that  is  entirely  local  in  its  interests,  as 
for  example,  a  municipal  water-works  system,  or  a  local  electric- 
light  or  gas  company,  may  properly  have  its  rates  fixed  without 
much  regard  to  the  rates  being  charged  by  similar  utilities  in  other 
localities  where  operating  expenses  may  be  lower  or  higher,  the 
quantity  and  local  habits  of  use  of  service,  or  the  amount  of 
investment  required  is  entirely  dissimilar.  In  instances  where 
such  monopolistic  utilities  are  being  considered,  the  principles 
to  apply  are  not  in  all  respects  the  same  or  comparalile  in  ascer- 
taining fair  rates,  that  hold  if  competition  is  allowed  to  prevail. 
The  rates  to  be  charged  for  local  service  by  a  local  monopoly  is 
distinct  from,  and  not  controlled  by,  the  rates  permitted  in  some 
other  locality;  the  local  rates  may  primarily  be  determined 
from  a  consideration  of  the  value  of  the  property  but  such  basis 
alone  will  not  apply  where  competition  exists,  as  in  the  case  of 
two  or  more  railroads  operating  between  the  same  terminals. 
Under  such  competitive  circumstances,  the  rates  for  one  road 
must  necessarily  be  fixed  from  a  consideration  of  what  is  chaiged 
by  the  other  road  and  perhaps  without  much  relation  to  the  value 
of  the  respective  railroads. 

For  example,  between  New  York  City  and  Buffalo,  there  are 
five  steam  railroads,  with  entirely  different  grades;  some  trav- 
ersing valleys  and  being  fairly  level,  while  others  have  heavy 
grades.  One  is  a  four-track  road  of  the  best  type  of  construction ; 
the  others  have  less  track  capacity,  but  represent  a  greater  or  less 
investment  per  unit  of  length,  on  accovmt  of  tunnels,  or  other 
local  conditions;  nevertheless,  the  rates  for  freight  are  identical 
between  the  two  points  named  over  all  of  these  routes,  and  except 
for  slight  differentials  with  regard  to  one  road,  the  passenger 
rates  are  the  same.  A  valuation  of  the  properties  of  these  five 
roads  would  show  greatly  varying  investments,  and  yet,  in  order 
to  maintain  their  respective  amounts  of  business,  the  roads  nuist 
continue  to  make  the  same  charge  for  the  same  service,  although 


FUNDAMENTALS  IN  VALUATION  :ir, 

that  charge  may  in  tlic  one  (;ase  earn  a  haiulsonio  roturn  (o  the 
investors  and,  in  another  case,  hardly  earn  operating  and  depre- 
ciation charges.  The  Interstate  Commerce  Commissioners  have 
recognized  this  condition  of  affairs  and  stated  that  rates  cannot 
1)6  based  on  valuation  alone,  although  that  necessarily  is  one  of 
the  elements  to  be  taken  into  consideration. 

"With  the  railroad,  however,  this  is  entirely  different  for  the  reason 
that  it  seldom  happens  that  a  single  railroad  can  be  considered  by  itself. 
The  greater  part  of  the  business  of  the  railways  of  the  United  States 
is  subject  to  competitive  conditions  of  one  sort  and  another  which  arc 
largely  controlling  so  that  the  rates  of  one  are  necessarily  bound  up 
with  those  of  another.  A  moment's  thought  will  show  the  extent  to 
which  this  is  true." 

"It  is  impossible  to  shake  a  single  railroad  free  from  every  other  and 
fix  its  charges  upon  the  basis  of  a  fair  return  upon  its  fair  value  as  you 
would  in  case  of  a  gas  or  water  plant.  The  rate  established  for  one,  of 
necessity  influences  and  frequently  absolutely  determines  the  rate  of 
all,  a  fact  which  must  never  be  forgotten  in  discussing  the  subject."' 

In  attempting  to  get  at  the  value  of  utility  property  certain 
peculiar  or  local  qualifying  conditions  may  fairly  modify  the 
results. 

"The  first  railroad  which  the  Commission  is  proceeding  to  survey 
in  what  is  known  as  the  Pacific  District  is  the  San  Pedro,  Los  Angeles 
&  Salt  Lake,  extending  from  San  Pedro,  California,  to  Salt  Lake  City, 
Utah,  some  800  miles.  Most  of  this  road  has  been  built  in  compara- 
tively recent  times,  and  the  circumstances  and  cost  of  construction  are 
fairly  well  known. 

"The  course  of  the  road  is  for  the  most  part  through  an  arid  desert. 
A  certain  section  of  it,  when  built,  was  located  where  no  man  tliouglit 
it  could  ever  be  disturbed  by  floods,  yet  shortly  after  it  was  opened  for 
operation  the  floods  Came  and  carried  out  this  portion.  It  was  at  ont-c 
reconstructed  upon  a  new  location  supposed  to  be  beyond  all  possible 
danger  from  a  recurrence  of  the  previous  disaster,  nevertheless  the 
waters  again  came  and  washed  away  this  same  section;  whereupon 
it  was  rebuilt  upon  a  third  location,  beyond  all  possible  reach  of  future 
trouble  from  this  source. 

"Considering  the  nature  of  the  road  and  the  people  who  were  in- 
terested in  its  construction,  it  seems  probable  that  due  caution  was 
exercised  in  the  original  location;  that  is,  that  a  reasonably  prudent 
man  building  this  railroad  as  those  men  did,  to  be  operated  by  them  as 

'"The  Valuation  of  Railroads"  by  Hon.  C.  A.  Prouty,  delivered  before  the  Second 
Annual  Meeting  of  the  Chamber  of  Commerce  of  the  United  States,  Washington,  Feb.  11, 
12  and  13,  1914. 


36  VALUE  FOR  RATE-MAKING 

a  railroad,  would  have  located  it  as  it  was  located.  It  is  undoubtedly 
true  that  the  second  location  was  made  with  great  care,  and  was  be- 
lieved to  be  beyond  possible  danger.  It  has  cost  a  large  sum  more  to 
rebuild  this  road  than  it  would  have  originally  cost  to  construct  it 
where  it  is  to-day.  Now  in  determining  the  value  of  this  property, 
what,  if  any,  allowance  is  to  be  made  for  this  experimental  outlay? 
If  the  government  itself  had  constructed  this  railroad  it  probably  would 
have  had  the  same  experience  and  would  have  expended  the  same 
amount  of  money  which  the  owners  actually  did. 

''This  illustration  puts  the  question  in  a  very  striking  form,  but  the 
same  idea  enters  more  or  less  into  the  valuation  of  most  of  the  railroads 
of  this  country.  There  has  of  necessity  been  a  certain  amount  of 
experiment  before  hitting  on  the  right  and  proper  thing.  Does  this 
development  expense  substitute  an  element  of  value  which  may  be 
recognized  to-daj^  or  must  the  owners  of  these  public  utilities  stand  the 
loss  of  their  mistakes  in  the  same  way  that  the  owner  of  a  private 
enterprise  would?  Vast  sums  of  money  are  involved  in  the  answer  to 
that  very  simple  question. 

"Take  another  illustration  of  a  different  character.  Some  years 
ago  in  a  case  pending  before  the  Commission  the  Northern  Pacific 
Railway  Companj^  had  occasion  to  prove  the  value  of  its  property,  and 
it  did  so  by  showing  the  cost  of  reproduction.  For  this  purpose  it 
gave  the  units  which  entered  into  that  railroad  as  it  then  stood.  Among 
other  things  it  showed  the  amount  of  land  upon  which  its  right-of-way 
was  located  and  what  it  would  cost  to  acquire  that  land  for  railroad 
purposes  at  that  time,  claiming  that  this  cost  of  reproduction  was  the 
value  of  the  property. 

"The  Northern  Pacific  runs  through  the  City  of  Spokane.  When 
the  road  was  built,  that  city  was  of  small  account  but  it  has  come  to 
be  of  much  account,  and  in  the  process  of  development  it  has  grown  up 
on  both  sides  of  this  railroad.  The  Northern  Pacific  claimed,  and  it 
may  very  well  have  been  true,  that  the  cost  of  acquiring  its  right-of-way 
through  the  heart  of  the  city  of  Spokane  at  the  time  of  the  hearing 
would  be  at  least  $5,000,000.  The  original  cost  to  the  railroad  was 
nothing,  the  right-of-way  having  been  entirely  donated  either  by 
the  Government  or  l)y  private  Ijenefaction.  Now  to  whom  belongs  this 
$5,000,000?  Has  the  Northern  Pacific  the  right  to  tax  the  public 
for  a  return  upon  that  amount?  Whether  it  has  is  a  thing  of  great 
consequence,  for  nearly  one-fourth  of  the  entire  value  of  the  Northern 
Pacific  Railway,  as  shown  in  that  proceeding,  was  the  value  of  its  right- 
of-way,  much  of  which  was  due,  as  in  the  City  of  Spokane,  to  increase 
in  value  over  its  original  cost.  This  question  of  the  unearned  increment 
presents  in  the  valuation  of  our  railways  a  difficult  problem. 

"Illustrations  like  those  two  might  be  indefinitely  multiplied,  but 
these  are  sufficient  to  cxliibit  the  thought  I  wish  to  emphasize,  namely, 


FUNDAMENTALS  IX  VALUATION  37 

that  this  valuation  of  our  railways  is  not  a  mere  engineering  problem, 
involving  the  cost  of  reproduction  or  the  amount  of  depreciation  alone. 
Indeed,  it  is  not  properly  an  engineering  problem  at  all,  but  rather  a 
social  and  economic  problem;  a  legal  problem;  in  its  final  analysis  a 
political  problem.  It  is  for  the  Commission  first  of  all  to  ascertain 
all  these  facts,  and  from  them  to  deduce  what  in  its  opinion  is  the  fair 
value  of  the  properties. 

"To  marshal  every  fact  obtainable  with  respect  to  the  present 
condition  and  the  past  history  of  our  railways,  and  from  a  just  con- 
sideration of  all  these  facts  to  determine  the  fair  value  of  the  proi)erties 
to-day."i 

It  will  be  seen  that  the  rates  charged  by  one  road  cannot  be 
fixed  by  it,  or  even  by  the  Interstate  Commerce  Commission, 
without  consideration  of  what  other  roads  will  charge  for  similar 
traffic  between  the  same  points,  otherwise  such  a  road  would  im- 
mediately begin  to  attract  or  drive  away  business  to  the  detri- 
ment or  advantage  of  the  competing  lines.  This  matter  was 
very  clearly  demonstrated  in  the  Minnesota  rate  cases,  where  the 
Supreme  Court  ordered  the  Great  Northern  and  Northern  Pacific 
Railroads  to  reduce  their  rates  between  certain  points,  although 
permitting  the  St.  Louis  and  Minneapolis  Railroad  to  continue 
the  existing  rate.  The  latter  road,  unable  to  continue  getting  its 
business  at  the  higher  rate,  was  compelled  to  meet  the  reduction 
made  in  accordance  with  the  Court's  order  by  its  two  competitors 
and  therefore,  reduced  its  own  rates,  although  thereby  it  was 
unable  to  earn  a  fair  return  upon  the  value  of  its  property. 

Hence  it  will  be  seen  that  rate-making  in  connection  with 
purely  local  monopolies  may  proceed  on  one  basis  that  is 
different  from  that  which  can  be  assumed  as  applicable  to  utility 
properties  competing  with  one  another. 

Until  comparatively  recent  years,  corporations,  like  individ- 
uals, have  been  permitted  to  largely  regulate  their  own  affairs. 
With  the  development  of  corporations  that  have  gained  complete, 
or  practically  complete,  control  of  any  given  fine  of  comnuMcud 
activity,  there  has  arisen  a  popular  demand  for  the  restriction, 
regulation,  or  disintegration  of  such  monopolies.  This  recent 
demand,  called  socialistic  by  some,  is  so  contrary  to  what  custom 
had  previously  permitted,  and  even  courts  had  sanctioned,  that 
many  still  believe  the  rights  of  the  monopofistic  corporations 

1  "The  Valuation  of  Railroads"  by  Hon.  C.  A.  Prouty,  delivered  before  the  Second  Annual 
Meeting  of  the  Chamber  of  Commerce  of  the  United  States,  Washington,  Feb.  11.1- 
and  13,  1914. 


1980 


38  VALUE  FOR  RATE-MAKING 

have  been  infringed  and  their  property  is  being  confiscated,  as  the 
result  of  governmental  regulation  or  disintegration.  Where 
bona  fide  competition  exists  it  usually  succeeds  in  forcing  satis- 
factorily low  rates  in  industrial  enterprises  and  it  is  in  the 
attempt  to  restore  former  conditions  of  free  competition  that  the 
Sherman  Act  was  passed  by  the  Federal  Government.  Its 
enforcement  it  is  still  hoped  by  many,  will  succeed  in  restoring 
free  competition,  with  its  accompanying  lower  prices  and  the 
former  incentive  and  stimulus  to  invention  and  development  in 
industrials,  but  competition  has  been  shown  to  be  and  is  generally 
accepted  to  be  the  wrong  method  by  which  to  control  public 
utilities. 

While  it  may  be  considered  doubtful  whether  the  artificial  dis- 
memberment of  monopolies  can  result  in  restoring  bona  fide 
competition,  there  is  no  question  but  that  in  many  instances 
monopolies  are  desirable.  They  avoid  duplication  of  investment, 
usually  reduce  charges  per  unit  manufactured,  proportionately 
reduce  overhead,  non-productive  expenses  of  a  corporation,  and 
eliminate  the  losses  frequently  involved  in  real  competition, 
which  losses  the  public,  or  the  investor,  must  ultimately  bear. 
Whatever  may  be  accomplished  in  the  way  of  maintaining 
competitive  conditions  between  individuals  or  corporations 
engaged  in  the  same  lines  of  business,  monopolies  must  of  neces- 
sity always  exist  in  certain  business  operations.  Such  monopolies 
should  be  recognized  as  desirable  and  beneficial  as  their  work 
cannot  be  done  equally  well  under  competitive  conditions;  for 
example,  in  the  telephone  business,  the  electric  light  and  power 
business,  the  surface  railway,  the  gas  or  water-works  business  for 
towns  and  villages,  and  even  most  cities.  Where  monopolies 
are  recognized  as  proper  and  permitted  to  exist,  regulation  of 
rates  by  governmental  authority  follows  almost  as  an  axiom. 
Monopolistic  corporations  are  granted  franchises,  frequently 
also,  the  right  of  eminent  domain,  they  are  given  the  use  of  the 
streets  and  public  highways,  with  other  privileges  entirely 
unique  and  distinct,  so  that  they  may  properly  be  held  strictly 
accountable  to  the  public  which  has  given  them  such  endow- 
ments. As  their  business  is  practically  assured,  free  from  com- 
petition, as  long  as  the  service  rendered  is  of  first-class  quality, 
they  are  not  entitled  to  charge  unfair  or  exorbitant  rates  and 
their  earnings  may  properly  be  reduced  to  a  fair  return  on  the 
vahio  of  their  property  being  used  for  the  service  of  the  public. 


FUNDAMENTALS  IN  VALTWTTON  39 

This  condition  holds,  not  only  with  regard  to  monopolies,  that 
may  be  formed  in  the  future,  but  also  with  respect  to  those 
already  in  existence,  provided  in  fixing  the  return  allowed  the 
latter  corporations,  consideration  is  given  to  the  fact  that  they 
created  investments  under  more  hazardous  conditions  than  those 
existing  under  a  rate  of  return  now  considered  fair. 

In  considering  values  found  by  appraisals  for  the  purpose  of 
determining  the  fair  rate  of  return  to  be  allowed  competing  utili- 
ties, such  as  steam  railroads,  there  must  also  be  recognized  the 
fundamental  fact  with  regard  to  the  existing  tariffs,  namely,  that 
tariffs  between  certain  competing  centers  are  absolutely  the  same 
irrespective  of  the  distance  or  the  route,  or  the  value  of  the  prop- 
erty used.  In  many  instances,  this  equality  of  tariffs,  regard- 
less of  distance,  results  from  natural  commercial  conditions;  for 
example,  the  tariffs  from  New  York  to  any  one  of  a  series  of  cities 
on  the  Mississippi  River  is  125  per  cent,  of  the  tariff  from  New 
York  to  Chicago,  whether  that  city  is  practically  west  of  Chicago, 
or  west  of  New  Orleans.  In  the  same  way,  shipments  from  Bos- 
ton to  Chicago  might  move  via  Asheville,  N.  C,  over  a  route 
1,786  miles  in  length,  with  the  same  charges,  as  over  the  direct 
line  only  1,004  miles  in  length.^ 

These  uniform  tariffs  are  maintained  in  order,  first,  to  prevent 
rate  wars,  which  would  result  in  bankruptcy  to  the  least  favored 
lines,  and  second,  to  permit  the  delivery  of  merchandise  of 
similar  characteristics  from  widely  divergent  points  to  the  com- 
mon center,  or  vice  versa.  Thus  it  will  be  seen  that,  not  from 
choice,  but  because  of  economic  reasons,  the  existing  type  of  dis- 
criminatory railroad  tariffs  have  been  built  up  and  developed 
and  must  be  maintained  to  permit  commerce  to  move  freely  in 
every  direction  and  to  maintain  markets  at  a  parity,  thereby 
practically  eliminating  distance  over  wide  areas  for  interstate 
commerce.  Under  such  conditions  "regional  rates"  are  properly 
determined  and  fixed  from  a  consideration  of  the  value  of  the 
various  properties  affected. 

If  rates  are  determined  by  the  value  of  the  railroad  having  the 
least  investment,  what  will  become  of  the  railroad  with  the  large, 
or  perhaps  excessive  investment?  On  the  other  hand,  if  a  fair 
rate  is  allowed  the  railroad  having  the  largest  investment,  the 
line  having  the  least  investment  will  obtain  unduly  large  profits 
and  be  tempted  to  cut  rates  and  thereby  still  further  increase 

'  Senate  Committee,  1905  Digest,  App.  LL,  page  10. 


40  VALUE  FOR  RATE-MAKING 

its  Ijusiness  and  earnings.  Evidently,  valuation  alone,  for  com- 
petitive railways,  cannot  be  considered  as  a  basis  for  fixing  rates. 
Other  considerations  must  be  the  time  required  in  rendering  the 
service,  the  quality  of  that  service,  the  densit}^  and  direction  of 
traffic,  competition,  the  requirements  of  the  isolated  communi- 
ties, along  the  lines  of  the  respective  railways  and  worth  of  the 
service. 

That  competition  between  railroads,  but  also  from  that  due  to 
water  transportation,  is  a  governing  factor  in  fixing  railroad  rates, 
regardless  of  the  fair  value  of  the  property  in  service,  has  been 
recognized  by  the  Interstate  Commerce  Commission  in  more  than 
one  case. 

"First. — Is  it  true  that  the  long-distance  rate  is  forced  by  water 
competition?  The  evidence  in  this  case  conclusively  shows  that  wool 
is  transported  from  Pacific  coast  terminals  to  New  York  for  not  ex- 
ceeding 65  cts.  per  100  lb.  It  is  plain  that  rail  carriers  could  hardly 
maintain  a  raU  rate  exceeding  the  present  dollar  charge.  We  find, 
therefore,  that  water  competition  does  force  the  rate  of  $1  from  Pacific 
coast  terminals  to  the  Atlantic  seaboard. 

Second. — Is  the  long-distance  rate  which  has  been  established  in  view 
of  water  competition  less  than  would  otherwise  be  reasonable? 

Upon  this  point  the  finding  must  be  that  it  is.  This  rate  applies 
for  a  distance  of  3,000  miles,  and  we  have  held  in  this  proceeding  that 
$1  would  be  a  reasonable  rate  for  a  very  much  less  distance  over  these 
same  lines."' 

While  competition  may  force  such  low  rates  as  between  steam 
railroads  for  example  as  to  prevent  even  a  fair  return  on  the 
physical  value  of  the  property  used  in  rendering  the  service,  such 
basis  of  return  on  the  value  of  the  physical  property  of  utilities 
generally,  is  usually  not  considered  fair  and  adequate  earnings. 

The  principles  are  very  clearly  discussed  in  the  following  extract 
from  the  Commission  reports,  and  the  general  statements  not 
only  apply  to  rate-making  for  railroads,  but  also  for  monopolistic 
utilities,  such  as  electric  light,  gas  and  similar  corporations: 

"Is  a  rate  unreasonable  because  it  does  not  pay  its  full  share  of  taxes, 
fixed  charges,  and  dividends?  At  the  end  this  is  the  question  to  which 
we  come  in  this  case.  The  carriers  themselves  having  fixed  these  rates 
under  the  mandate  of  the  law  that  they  shall  fix  just  and  reasonable 

'  Opinion  No.  1830  in  the  Matter  of  the  Investigation  of  Alleged  Unreasonable  Rates  and 
Practices  Involved  in  the  Transportation  of  Wool,  Hides,  and  Pelts  from  Various  Western 
Points  of  Origin  to  Eastern  Destinations. 


FUNDAMENTALS  IN  VALUATION  41 

rates,  have  they  justified  higlicr  rates  by  showing  tliat  the  existing 
rates  which  they  had  fixed  fall  somewhat  short  of  meeting  all  the  related 
expenses  which  the  carrier  must  bear,  not  only  for  transportation  but  to 
secure  an  adequate  return  upon  its  property?  Let  us  see  where  this 
doctrine  would  lead.  If  a  carrier  may  raise  all  rates  to  a  basis  where 
each  will  bear  its  share  of  cost,  including  all  costs,  and  no  lower  rate  is 
reasonable,  then  it  must  follow  that  all  rates  are  unreasonable  which 
yield  to  the  carrier  a  greater  return  than  such  cost.  Under  such  theory 
what  would  be  the  rate  on  tea  or  silks,  or  high-priced  horses,  or  delicate 
machines?  Is  there  to  be  no  classification  of  freight  excepting  upon  the 
basis  of  cost  of  transportation  plus  insurance  risk?  If  so  the  tariffs 
of  every  railroad  in  the  United  States  must  suffer  a  revolutionary  change. 
In  all  classification  consideration  must  be  given  to  what  may  be  termed 
public  policy,  the  advantage  to  the  community  of  having  some  kinds  of 
freight  carried  at  a  less  rate  than  other  kinds.  And  this  is  the  true 
meaning  of  the  phrase  'what  the  traffic  will  bear.'  It  expresses 
the  consideration  that  must  be  shown  by  the  traffic  manager  to  the 
need  of  the  people  for  certain  commodities.  He  accordingly  imposes  a 
higher  rate  upon  what  may  be  termed  luxuries  as  compared  with  that 
imposed  upon  those  articles  for  which  there  is  a  more  universal  demand. 
He  also  gives  consideration  to  the  fact  that  the  rate  so  imposed  enters 
into  the  ultimate  price  to  the  consumer  to  but  a  small  degree  when  the 
article  is  one  of  high  value,  and  that  those  in  the  community  who  can 
afford  to  purchase  such  articles  can  well  afford  to  pay  a  rate  greater  than 
that  which  could  reasonably  be  imposed  upon  the  general  public  for 
commodities  of  common  use.  In  this  sense  what  the  traffic  will  bear 
and  the  value  of  the  service  are  analogous.  No  one  would  claim  that  a 
carrier  was  violating  its  duty  under  the  law  in  charging  throe  times  the 
rate  upon  oriental  rugs  that  it  imposed  upon  cotton.  This  would 
not  be  undue  discrimination  as  between  commodities,  even  though  it 
costs  no  more  to  transport  the  rugs  than  it  did  the  cotton,  assuming 
both  to  be  carried  at  the  owner's  risk,  for  the  one  does  not  compete 
with  the  other,  and  one  may  reasonably  bear  a  higher  rate  than  the  other 
upon  pubhc  grounds.  It  must  be,  therefore,  that  this  Commission,  under 
the  amendment  to  section  1  passed  by  Congress  in  1910,  giving  to  us 
the  control  of  freight  classification,  has  power  to  determine  the  reason- 
ableness of  the  differences  that  are  made  between  the  rates  made 
applicable  to  the  various  kinds  of  commodities  transported.  We  may 
not  say  that  a  rate  shall  be  fixed  so  as  to  meet  the  requirements  or 
needs  of  any  body  of  shippers  in  their  efforts  to  reach  a  given  market, 
nor  may  we  establish  rates  upon  any  articles  so  low  that  they  will  not 
return  out-of-pocket  cost.  Neither  could  we  fix  an  entire  schedule 
of  rates  which  would  yield  an  inadequate  return  upon  the  fair  value 
of  the  property  used  in  the  service  given.  There  is,  however,  a  zone 
within  which  we  may  properly  exercise  'the  flexible  limit  of  judgment 


42  VALUE  FOR  RATE-MAKING 

which  belongs  to  the  power  to  make  rates.'  These  are  the  words  of 
the  Chief  Justice  of  the  Supreme  Court,  206  U.  S.  126.  There  is  no 
flexible  limit  of  judgment  if  all  rates  must  be  upon  a  level  of  cost,  and 
out  of  every  dollar  paid  to  the  carrier  must  come  a  fixed  amount  of 
return  for  capital  invested.  The  recognition  of  such  a  doctrine  has 
never  been  suggested  either  by  Congress  or  the  Supreme  Court.  A  just 
and  reasonable  rate  must  be  one  which  respects  alike  the  carriers' 
deserts  and  the  character  of  the  traffic.  It  cannot  be  a  rate  that  takes 
from  the  carrier  a  profit  and  thus  favors  the  shipper  at  the  carrier's 
expense,  nor  is  it  one  which  compels  the  shipper  to  yield  for  the  trans- 
portation given  a  sum  disproportionate  either  to  the  service  given  by 
the  carrier  or  to  the  service  rendered  to  the  shipper.  The  words  'just 
and  reasonable'  imply  the  application  of  good  judgment  and  fairness, 
of  common  sense  and  a  sense  of  justice  to  a  given  condition  of  facts. 
They  are  not  fixed,  unalterable,  mathematical  terms.  Their  meaning 
implied  the  exercise  of  judgment,  and  against  the  improper  exercise  of 
that  judgment  the  Constitution  gives  protection,  at  least  as  far  as  the 
carriers  are  concerned."' 

Purpose  Affects  Valuation. — Now,  that  the  general  public  has 
become  interested  in  the  subject  of  valuations,  there  is  being 
evolved  a  large  amount  of  superficial,  unscientific  propaganda. 

Although  specialists  in  engineering,  economics,  accounting  and 
law,  have  been  discussing  and  applying  methods  of  valuation  for 
the  past  15  years,  or  more,  and  although  the  State  of  Texas 
made  an  appraisal  of  its  steam  railroads  over  20  years  ago  the 
relative  amount  of  property  appraised,  compared  with  the  total 
investment  in  utilities  throughout  the  United  States,  is  com- 
paratively small.  In  fact,  there  has  been  so  much  difference  of 
opinion  between  those  having  to  do  with  the  subject  that  at 
present  there  cannot  be  said  to  be  unanimous  agreement,  even  on 
the  principles  involved. 

It  is  frequently  claimed  that  the  valuation  of  utility  property 
should  be  the  same  regardless  of  the  use  to  be  made  of  the  valua- 
tion. In  a  l)road  sense  this  is  true.  A  utility,  however,  may  own 
property,  a  portion  of  which  is  not  used  in  rendering  service  to  the 
public  and,  while  the  value  of  the  entire  property  could  properly 
be  considered  in  a  capitalization  case,  only  the  value  of  such 
property  as  is  used  in  the  service  rendered  could  be  considered 
in  a  rate  case,  so  that  the  two  reported  values  would  be  different 

'  Report  and  Order  of  the  Commission,  No.  1806,  page  623;  In  the  matter  of  the  investi- 
gation and  Huspension  of  advances  in  rates  for  the  transportation  of  coal  by  the  Chesapeake 
&  Ohio  Itailway  Company,  Baltimore  &  Ohio  Railroad  Company,  Norfolk  &  Western 
Railway  Company,  the  Kanawha  &  MichiKan  Itailway  Company,  and  their  connections. 


FUNDAMENTALS  IN  VALUATION  43 

depending  on  the  use  to  be  made  of  the  vuhiation.  Similarly, 
the  laws  of  many  States  indicate  special  valuations  for  purposes 
of  taxation,  and  these  laws  differ  among  the  different  States. 
Consequently,  in  any  valuation,  the  basis  upon  which  it  is  to  be 
made  and  the  way  it  is  to  be  used  must  ])e  considered. 

"If  it  is  decided  that  a  public  utility  should  be  taxed  on  its  total 
value  as  a  going  concern — that  is,  its  commercial,  market  or  sale  value — 
then  franchise  and  going  value  will  be  included.  If,  on  the  other  hand, 
the  public-utility  plant  is  to  be  taxed  precisely  as  otlier  real  estate,  the 
cost  of  reproduction  less  depreciation  will  be  the  basis.  There  is  no 
inherent  inconsistency  in  using  one  method  of  valuation  for  tax  purposes 
and  another  method  for  rate  purposes." 

"Different  methods  of  estimating  the  value  of  property  may  properly 
be  employed  when  it  is  valued  for  different  purposes."^ 

It  is  unquestionably  true  that  a  valuation  determined  solely 
with  reference  to  the  specific  case  and  particular  purpose  for 
which  the  valuation  is  necessary,  alone  meets  the  condition, 
"fair  value."  The  courts  have  recognized  the  truth  and  reason- 
ableness of  this  statement  and  they  have  rendered  decisions  hav- 
ing in  mind  whether  the  valuation  is  for  purposes  of  purchase  and 
sale,  or  taxation,  or  rate-making,  or  capitalization.  It  may 
happen  that  the  fair  value  will  be  found  to  be  the  same  for  one 
purpose  as  another,  but  not  necessarily  so. 

"It  appears  to  us  that  considerable  confusion  in  the  discussion  of  the 
subject  of  valuation*  *  *  arises  from  a  confusion  of  the  terms  'cost' 
and  'value.'  Cost  is  a  definite  amount  regardless  of  purpose.  The 
actual  cost  and  the  reproduction  cost  of  any  structure  may  be  deter- 
mined without  reference  to  the  purpose  for  which  such  estimates  may 
later  be  used.  This  is  what  is  often  meant  when  it  is  said  that  valuation 
should  be  the  same  regardless  of  purpose.  All  that  is  really  intended 
is  that  actual  cost  or  reproduction  cost  should  be  the  same.  But  cost 
is  not  necessarily  value  for  any  purpose,  though  it  is  an  element  in 
estimating  fair  value  for  almost  any  purpose.  Thus  fair  value  for  rate 
purposes  may  be  based  largely  on  actual  cost  or  on  reproduction  cost, 
or  on  a  composite  of  actual  cost,  and  reproduction  cost.'"'^ 

Value  for  rate-making  can  seldom,  if  ever,  properly  be  used  as 
the  value  in  the  case  of  purchase  and  sale.     If,  in  the  latter  case, 

I  Ex-Commissioner  M.  Basset,  National  Association  of  Railway  Commissioners,  Wash- 
ington, D.  C,  Oct.  10-13,  1911. 

^  Proceedings  of  the  23rd  Annual  Convention;  page  145,  October,  1911;  National  Associa- 
tion of  Railway  Commissioners. 


44  VALUE  FOR  RATE-MAKING 

there  was  included  with  the  title  to  property  transferred,  a  cash 
reserve  fund  equal  in  amount  to  the  difference  between  the 
present  depreciated  value  of  the  property  and  its  cost  of  reproduc- 
tion new,  then  only  in  such  case  would  the  sales  value  be  the  same 
fair  value  that  properly  should  be  used  for  rate-fixing  purposes. 
It  is  possible  that  in  the  future,  under  Public  Service  Regulation, 
accumulated  reserve  funds,  corresponding  to  the  total  amount  of 
estimated  depreciation  on  the  property  may  be  held  to  be  a  part 
of  the  property  but  usually,  under  existing  conditions,  the 
purchaser  of  utility  property  must  assume  the  obligations  to 
make  good,  in  the  future,  all  accruing  depreciation,  to  cover 
which  few  existing  utilities  have  sufficient  reserve  funds  in  hand. 

For  purposes  of  capitalization,  there  must  usually  be  allowed 
an  appreciably  larger  value  for  the  par  value  of  securities  than 
the  valuation  of  the  physical  property  plus  all  intangible  charges, 
due  to  the  fact  that  bonds  are  almost  always  sold  below  par 
value;  in  some  States,  stock  is  legally  so  sold. 

It  is  true  that  in  some  instances,  the  courts,  even  the  Supreme 
Court,  have  implied  that  a  lower  value  is  properly  allowable  for 
purpose  of  rate-making  than  in  case  of  sale,  but  the  more  recent 
rulings  do  not  seem  to  sustain  that  view.  As  a  matter  of 
common  sense,  the  reverse  of  such  ruling  would  more  nearly  ac- 
cord with  common  practice  and  experience.  No  investor  will 
pay  a  higher  price  for  a  property  than  that  upon  which  he  will  be 
allowed  to  make  earnings  present  and  prospective.  If  such 
earnings  or  rate  of  return  is  fixed  by  the  courts  at  5  per  cent.,  for 
example,  on  the  appraised  fair  value  of  the  property,  when 
money  is  earning  6  per  cent.,  the  price  the  investor  will  pay  for 
such  property  is  less  than  fair  value  as  determined  by  valuation; 
consequently,  the  sale  price  to  any  intelligent  buyer  will  never  be 
larger  than  the  value  allowed  for  rate-making.  In  this  connection 
attention  should  be  called  to  the  anomalous  position  that  has 
been  taken  by  courts  in  holding — very  {)roperly — that  utility 
corporations  must  even  against  their  wishes,  make  extensions 
and  additions  to  keep  up  to  and  meet  the  demands  of  the  public 
but,  nevertheless — it  would  seem  very  improperly — refusing,  as 
the  Supreme  Court  has  done,  to  protect  the  utilities  against 
reduction  in  rate  as  long  as  the  earnings  are  sufficient  to  provide 
merely  a  "fair  return"  upon  their  property,  which  must  be  taken 
to  include  such  extensions  as  have  been  ordered.  When  "fair 
return"  is  held  to  be  practically  6  per  cent,  as  in  the  Consolidated 


FUNDAMENTALS  IN  VALUATION  45 

Gas  Co.  case  and  only  4>^  per  cent.  (  6  per  cent,  less  1)^  per  cent, 
to  cover  estimated  depreciation)  as  in  the  Knoxville  Water  Co. 
case,  free  capital  cannot  ordinarily  be  induced  to  invest,  and 
additional  capital  is  only  obtained  on  such  basis  by  corporations 
existing  under  the  most  favorable  conditions  or  because  they  are 
able  to  offer  preferred  securities.  Either  of  these  bases,  however, 
cannot  be  considered  a  fair  and  proper  basis  upon  which  to  fix  a 
fair  rate  of  return  for  the  ordinary  property,  or  the  entire  value  of 
utility  property. 

Value  for  rate-making  will  result  in  a  different  amount  than 
value  for  sale  or  for  taxation.  Abstractly  the  value  of  the  same 
items  must  be  the  same,  but  the  purpose  supplies  the  adjective 
which  modifies  the  final  result. 

It  is  inconsistent  to  include  in  the  value  for  taxation  the  in- 
tangible property  of  utilities  when  the  value  of  other  property 
excludes  the  same  or  similar  intangibles.  Again  there  may  be 
fundamental  differences  between  public  utilities  and  industrial 
corporations;  for  example,  in  the  former  the  total  revenue  may  be 
but  one-fifth  the  value  of  the  property  upon  which  taxes  are 
assessed,  while  with  the  latter  class,  the  revenue  may  be  five  or 
more  times  the  value  of  the  assessed  property  resulting  in  taking 
from  each  dollar  of  revenue  of  the  utility  twenty-five  times  the 
amount  taken  from  that  of  the  industrial  corporation.  If 
under-valuation  for  purposes  of  taxation  is  permitted  for  other 
property,  utility  property  should  be  similarly  equalized. 

In  the  matter  of  value  for  purpose  of  taxation,  conflicting 
decisions  have  been  made;  for  example,  the  County  Assessor  of 
Salt  Lake  County,  Utah,  held  in  the  case  of  the  Bingham  & 
Garfield  Railroad  that  although  the  road  had  a  considerably 
larger  revenue,  was  a  costly  one  to  build,  on  account  of  difficult 
engineering  problems,  and  while  on  the  basis  of  either  reproduc- 
tion or  investment  cost  the  value  of  the  property  would  be  very 
much  higher  than  the  Bingham  Branch  of  the  Denver  &  Rio 
Grande  Railroad,  nevertheless,  that  was  no  reason  why  the 
former  road  should  be  required  to  pay  more  than  its  share  of 
taxation,  as  both  roads  were  operated  between  the  same  points 
and  doing  similar  business  at  the  same  rates. 

On  the  other  hand,  Judge  Williard  of  the  United  States  Court, 
sitting  in  S.  Dakota,  held  in  one  case  with  certain  express  com- 
panies as  to  the  value  of  their  property  set  up  as  a  basis  of  taxa- 
tion,  but  in   a  second  and  later  rate  case  indicated  that   any 


46  VALUE  FOR  HATE-MAKING 

attempt  to  increase  the  tax  values  previously  established,  for  the 
purpose  of  rate-making,  was  an  attempt  to  trifle  with  the  Court, 
concluding  that  the  values  set  forth  at  the  tax  hearing  must 
govern  in  both  cases. 

Thus  it  will  be  seen,  except  in  the  last  case  cited,  the  term 
value  has  different  meanings  in  connection  with  public  utility 
properties,  the  same  as  in  ordinary  commercial  business.  As 
steel  has  no  value  for  food  purposes  or  wheat  as  structural 
material,  their  value  depending  upon  the  use  to  which  they  are 
put,  so  the  value  of  utility  property  depends  upon  its  use;  the 
purpose  of  the  valuation  must  ultimately  determine  the  value. 

"We  are  dealing,  not  with  exchange  values,  but  with  the  value  upon 
which  the  Company  is  entitled  to  earn  a  return."^ 

Gifts  and  Donations. — The  Constitution  of  the  United  States, 
by  the  Fifth  Amendment,  provides: 

"That  no  property  shall  be  taken  for  public  use  without  just  com- 
pensation." 

and  by  the  Fourteenth  Amendment: 

"That  all  persons  shall  be  entitled  to  equal  protection  of  the  laws." 

These  rights  must  be  respected  by  the  United  States  Government 
itself  as  well  as  by  the  State  legislatures  and  all  public  authorities 
or  courts.  It  makes  no  difference  whether  the  rightful  owner  has 
purchased  or  been  given  his  property,  neither  the  whole  of  it 
nor  any  part  of  it  can  be  transferred  or  taken  without  just  com- 
pensation. It  is  immaterial  whether  the  property  has  been  paid 
for  out  of  earnings  or  has  appreciated  in  value.  It  makes  no 
difference  whether  controlled  by  private  individuals  or  owned 
by  corporations,  it  cannot  be  confiscated  despite  any  act  of 
Congress  or  other  legislative  body.  If  the  value  of  the  property 
used  must  be  considered  in  determining  rates,  the  fixing  of  rates 
based  on  a  value  of  the  property  which  excludes  any  portion 
of  the  whole  property  because  it  may  have  been  donated,  paid 
for  out  of  just  dividends  or  accrues  from  appreciation  in  land, 
results  in  confiscation,  takes  from  the  value  of  the  property 
owned,  and  is  therefore  illegal. 

"These  cases  all  support  the  proposition  that  while  it  is  not  the  prov- 
ince of  the  courts   to  enter   upon  the  merelj'^  administrative  duty  of 

'  Judge  Miller  of  N.  Y.  Court  of  Appeals — People  ex  rel  Kings  Co.  Lighting  Co.  vs. 
Wilcox  et  nl,  210  N.   Y.  479. 


FUNDAMENTALS  IN  VALUATION  47 

framing  a  tariff  of  rates  for  carriage,  it  is  within  the  scope  of  judicial 
power  and  a  part  of  judicial  duty  to  restrain  anything  wliich,  in  the 
form  of  a  regulation  of  rates,  operates  to  deny  to  the  owners  of  property 
invested  in  the  business  of  transportation  that  equal  protection  which  is 
the  constitutional  right  of  all  owners  of  other  property.  There  is 
nothing  new  or  strange  in  this.  It  has  always  been  a  part  of  the  judicial 
function  to  determine  whether  the  act  of  one  party  (whether  that  party 
be  a  single  individual,  an  organized  body  or  the  public  as  a  whole) 
operates  to  divest  the  other  party  of  any  rights  of  person  or  property. 
In  every  constitution  is  the  guarantee  against  the  taking  of  private 
property  for  public  purposes  without  just  compensation.  The  equal 
protection  of  the  laws,  which,  by  the  Fourteenth  Amendment,  no  State 
can  deny  to  the  individual,  forbids  legislation,  in  whatever  form  it  may 
be  enacted,  by  which  the  property  of  one  individual  is  without  com- 
pensation wrested  from  him  for  the  benefit  of  another,  or  of  the  public. 
This,  as  has  been  often  observed,  is  a  government  of  law  and  not  a 
government  of  men,  and  it  must  never  be  forgotten  that  under  such  a 
government  with  its  constitutional  limitations  and  guarantees  the  forms 
of  law  and  the  machinery  of  government,  with  all  their  reach  and  power, 
must  in  their  actual  workings  stop  on  the  hither  side  of  the  unnecessary 
and  uncompensated  taking  or  destruction  of  any  private  property 
legally  acquired  and  legally  held."^ 

The  Supreme  Court  of  the  United  States,  as  recently  as  last 
June,  rendered  a  very  important  decision  reaffirming  its  earlier 
decisions  to  the  effect  that  property  owned  by  a  utility  belongs 
to  it,  regardless  of  the  fact  that  it  was  donated.  The  case 
arose  through  the  attempt  of  the  Federal  Government  to  compel 
forfeiture  of  the  unsold  portion  of  the  Oregon  &  California 
Railroad  land  grant  amounting  to  2,300,000  acres,  valued  at 
more  than  $30,000,000.  In  its  suit  the  Government  charged 
that  the  railroad  company  had  forfeited  its  rights  by  having 
violated  a  provision  which  required  it  to  sell  in  not  more  than 
160-acre  tracts  at  a  price  not  exceeding  $2.50  an  acre,  and  only 
to  actual  settlers.  The  Government  sought  to  prove  that  the 
company  had  sold  in  large  tracts  to  timber  companies  at  more 
than  $2.50  an  acre,  and  had  adopted  a  poHcy  to  sell  no  more  to 
any  purchaser  for  the  time  being.  The  railroad  company 
contended  that  the  provision  was  not  effective  because  the 
lands  were  unfit  for  settlement,  and  furthermore  urged  that 
the  Government  could  not  raise  the  question  of  forfeiture  be- 
cause of  long  acquiescence  in  the  company's  disregard  of  the 

1  Reagan  vs.  The  Farmers'  Loan  &.  Trust  Company,  154  U.  S.  302. 


48  VALUE  FOR  RATE-MAKING 

selling  provision.  Judge  McKenna,  writing  the  opinion,  said 
that  the  Government's  position,  in  claiming  that  the  conditions 
of  the  grant  regarding  sales  were  conditions  for  which  a  viola- 
tion worked  a  forfeiture,  was  untenable.  The  Court  held  that 
the  conditions  were  in  the  nature  of  "enforceable  covenants," 
and  that  the  Government  could  not  cancel  the  railroad  com- 
pany's grant.  The  Court,  however,  enjoined  for  a  six-month 
period  the  railroad  company  from  future  sales  in  violation  of 
the  conditions  of  the  grant,  so  that  Congress  would  have  a 
reasonable  time  in  which  to  act. 

Free  Service. — Public  utilities  have  frequently  been  obliged 
to  agree  to  render  "free  service"  in  the  form  of  transportation, 
lighting,  telephone  service  or  power,  for  which  no  direct  charge 
is  made.  The  consideration  for  such  "free  service"  is  usually 
a  franchise  right  to  use  the  public  streets  or  highways,  or  some 
other  concession  assumed  to  be  an  equivalent  of  the  service 
rendered.  Of  course,  such  "free  service"  is  not  without  ex- 
pense and  charge  to  someone.  Where  the  utilities  were  allowed 
to  make  their  own  tariffs  and  charges  for  service,  the  gratuitous 
rendition  of  a  limited  amount  of  service  may  have  come  out  of 
the  net  earnings  of  the  utility  itself,  and  in  that  way  the  public, 
or  its  agents,  were  benefited.  More  usually,  however,  the 
granting  of  favors  or  "free  service"  by  the  utility,  resulted  in 
failure  to  exact  all  that  otherwise  might  properly  be  asked 
of  the  utility,  and  thereby  the  public  became  the  real  loser. 
Under  public  utility  regulation,  the  cost  of  "free  service"  is 
included  with  the  other  expenses  which  go  to  make  up  the  total 
costs  of  service,  so  that  no  real  advantage  accrues  to  the  public 
as  the  rates  established  will  be  less  in  case  no  "free  service"  is 
rendered  than  when  the  cost  of  the  "free  service"  is  added  and 
included  in  fixing  tariffs  sufficiently  high  to  include  these  costs. 
Consequently,  the  whole  question  is  as  broad  as  long,  and  there 
is  no  advantage  in  taking  money  out  of  one  pocket  and  putting 
it  into  another,  particularly  as  such  process  results  in  involved 
questions  and  increased  difficulties  of  ascertaining  proper 
operating  costs. 

The  general  tendency  of  public  service  regulating  bodies  has 
been  to  abrogate  any  obligation  on  the  part  of  utilities  to  furnish 
"free  service,"  even  though  franchises  or  contracts  so  provide. 
This  attitude  and  action  of  public  authorities  has  been  passed 
upon  and  approved  by  the  courts.     The  legal  authorities  have 


FUNDAMENTALS  IN  VALUATION  49 

frequently  ruled  upon  the  right  of  the  legislature  to  even  abrogate 
contracts  made  by  municipalities,  so  that  public  commissions,  the 
creature  of,  and  acting  for  the  legislatures,  undoul)tedly  can 
abrogate  contracts  or  franchise  agreements  between  nninici- 
palities  and  corporations,  when  the  latter  consent  to  such 
abrogation. 

In  the  case  of  the  City  of  Worcester  against  the  Worcester 
Consolidated  Street  Railway  Company  (see  also  page  4),  the 
Court  passed  on  the  question  of  whether  the  company  could 
be  compelled,  under  the  clause  in  its  franchise,  to  pave  streets, 
and  the  Court  assumed  that  a  definite  contract  did  exist  between 
the  City  and  the  company,  but  that,  nevertheless,  the  Legislature, 
in  the  exercise  of  its  general  legislative  power,  could  a))rogate 
such  contract,  saying: 

"A  municipal  corporation  is  simply  a  subdivision  of  the  State." 
"If  these  restrictions  or  conditions  are  to  be  regarded  as  a  contract, 
we  think  the  Legislature  would  have  the  same  right  to  terminate  it, 
with  the  consent  of  the  Railroad  Company,  that  the  City  itself  would 
have."^ 

The  above  position  has  been  recently  affirmed  by  the 
New  Jersey  Court  in  a  very  similar  case.  The  Public  Service 
Electric  Company  of  New  Jersey,  or  its  predecessor,  had  entered 
into  a  specific  contract  with  the  City  of  Plainfield,  N.  J.,  for  the 
use  of  the  city  streets  for  its  poles  and  wires,  in  return  for  which 
the  company  agreed  to 

"light  by  electricity,  free  of  charge,  certain  municipal  buildings,  offices 
and  rooms,  owned  or  occupied  by  the  City  officers,"  etc. 

The  company  performed  its  part  of  the  contract  from  1898 
until  1913,  over  15  years;  then  the  company  refused  to  continue 
to  furnish  free  light,  pleading  that  the  Public  Utility  Law  of 
New  Jersey  prohibited  discrimination  and  therefore  the  company 
was  precluded  from  carrying  out  its  contract  by  the  statute  of 
the  Legislature.  The  Board  of  Utility  Commissioners  of 
Plainfield  made  an  order  directing  the  company  to  furnish  lights 
in  accordance  with  its  contract,  but  the  company  applied  to  the 
Court,  and  the  Court  rendered  a  decision,  speaking  as  follows: 

"We  think,  however,  that  the  Pubhc  Utilities  Act,  in  forbidding 
discrimination,  made  the  performance  of  this  contract  unlawful,  and 

J  196  U.  S.  552. 
4 


50  VALUE  FOR  RATE-MAKIXG 

that,  therefore,  the  prosecutor  (the  company)   could  not  continue  to 
perform  the  contract  without  being  guilt\'  of  viohition  of  that  statute."' 

The  Local  Board  contended  that  the  furnishing  of  free  lights 
to  the  City  was  not  discrimination,  but  the  Court  said: 

"No  other  evidence  is  required  or  necessary  than  is  furnished  by  the 
contract  to  demonstrate  that  the  preference  or  advantage  given  ))}'  the 
contract  is  undue  and  unreasonable  and  within  the  violation  of  the 
Public  Utilities  Act.  The  fact  that  there  was  such  undue  and  unrea- 
sonable preference  or  advantage  given,  is  sufficient  basis  to  set  aside 
the  order  made  by  the  Public  Utilities  Commissioners.' '^ 

Agency  Theory. — The  "original  cost"  basis  of  valuation  has 
been  used  by  those  advocating  the  theory  that  the  property  of  a 
public  utility  belongs  really  to  the  public  and  that  the  owners  are 
merely  the  trustees  or  agents  of  the  public.  This  theory  has  been 
developed  and  advocated  perhaps  most  strongly  by  some  mem- 
bers of  the  Railroad  Commission  of  the  State  of  California.  In 
the  recent  Antioch  decision  of  the  California  Commission  the 
fundamental  principles  involved  in  determining  the  basis  on 
which  return  should  be  allowed  were  discussed  at  length.  The 
Commission  brushed  aside  as  without  warrant  the  contention 
of  the  utility  that  the  basis  for  fixing  rates  should  be  reproduc- 
tion value  new  of  the  company's  physical  plant  plus  an  allowance 
for  going  value.  The  Commission  argued  that  a  utility  is  entitled 
to  a  reasonable  return  upon  money  honestly  and  wisely  expended 
for  the  public,  but  that  loss  due  to  abnormal  conditions,  bad  man- 
agement, poor  judgment,  and  lack  of  ordinary  care  and  foresight 
must  be  borne  by  the  utility  and  not  by  the  public.  In  develop- 
ing this  phase  of  the  subject,  Commissioner  Thelen  who  wrote 
the  opinion,  suggested,  that  in  many  respects  the  relation  between 
utility  and  its  consumers  may  be  compared  to  that  existing  be- 
tween principal  and  agent.  While  the  Cominission,  in  rendering 
its  final  decision,  accepted  the  conclusions  of  Commissioner 
Thelen,  as  to  values,  the  president  of  the  Commission,  Mr.  John  M. 
Eshleman,  dissented  from  his  fellow  commissioner  and  character- 
ized this  doctrine  of  agency  as  dangerous,  stating  that  the 
Supreme  Court  would  not  countenance  any  finding  to  the  effect 
that  owners  of  a  public  utility  hold  such  property  as  agents.  His 
exact  language  is  as  follows: 

•  Public  Service  Electric  Company  vs.  Board  of  Utility  Commissioners,  of  City  of  Plainfield, 
93  Atlantic  708. 


FUNDAMENTALS  IN  VALUATION  nl 

"Tlie  main  reason  then  why  I  do  not  accept  the  able  reasoning  of 
Mr.  Thelen  in  this  regard  is  that  it  wiU  merely  serve  longer  to  keep  us 
lulled  to  sleep  until  all  our  valuable  public  stores  and  privileges  shall 
have  been  given  away,  when  we  shall  awaken  to  the  painful  fact  that 
they  are  no  longer  ours,  just  as  we  are  now  made  to  know  that  the 
waters  of  our  rivers  and  streams,  incalculable  in  value,  are  for  nothing 
the  prize  of  the  alert  private  interest  merely  because  public  authority 
slept. 

"The  authorities  cited  do  not  at  all  convince  me  that  the  Supreme 
Court  will  ever  hold,  when  the  matter  is  directly  before  it,  that  the 
owners  of  a  public  utility  property  hold  such  property  as  an  agent  at 
all.  In  fact  that  Court  has  in  several  well-considered  cases  definitely 
decided  that  such  is  not  its  view.  Therefore,  if  we  are  to  escape  ex- 
cessive unearned  increments  and  rates  based  upon  the  gift  we  have 
made,  it  must  be  on  some  other  theory  than  that  the  owner  of  public 
utility  property  is  in  any  proper  sense,  as  to  such  property,  an  agent." 
******** 

"If  legal,  as  I  am  sure  it  is  not,  it  works  beautifully  as  to  those 
agencies  that  are  now  subject  to  regulation,  but  it  fails  as  to  other  agen- 
cies that  shall  hereafter  engage  in  business  which,  but  for  this,  would 
be  subject  to  regulation.  The  recent  case  of  the  Del  Mar  Light,  Water 
and  Power  Company  against  this  Commission  indicates  the  danger  to 
regulation  of  urging  this  doctrine.  A  public  utility  business  is  no  different 
from  any  other  business,  except  that  it  occupies  such  a  position  in 
society  by  reason  of  its  monopolistic  character  that  the  State,  under  its 
police  power,  may  regulate  it  both  as  to  the  price  for  which  and  those 
to  whom  it  shall  accord  its  service."^ 

Certain  utility  commissioners,  however,  are  not  the  only 
individuals  holding  that  utility  property  really  belongs  to  the 
public.  Dr.  Justice  Van  Fleet  comes  out  very  squarely  in  favor 
of  this  theory  in  a  decision  recently  rendered  in  the  San  Diego 
Water  Company  case,  where  he  said: 

"As  we  have  said,  it  is  not  the  water  or  the  distributing  works  which 
the  company  may  be  said  to  own,  and  the  value  of  which  is  to  be  as- 
certained. They  were  acquired  and  contributed  for  the  use  of  the 
public;  the  public  may  be  said  to  be  the  real  owner  and  the  company 
only  the  agency  of  the  public  to  administer  their  use."^ 

The  above  expression  of  opinion  has  been  approved  by 
Commissioner  Thelen  in  the  North  Coast  Water  Company  casc.^ 

1  Town  of  Antioch  vs.  Pacific  Gas  &  Electric  Company.  Case  No.  400;  decided  July  6, 
1914. 

*  San  Diego  Water  Company  vs.  San  Diego,  118  Cal.  556,  page  570. 

^Decision  No.  1110  in  the  matter  of  the  application  of  North  Coast  Water  Co.,  for 
authority  to  increase  the  rates  for  water  charged  to  Belvedere  Land  Co. 


52  VALUE  FOR  RATE-MAKING 

The  agency  theory  is  a  comparatively  recent  one  and  it  indi- 
cates the  tendency  of  the  times  and  a  willingness  on  the  part  of 
the  public  to  depress  the  value  of  corporation  property  without 
paying  the  present  value  therefor.  The  legal  relation  between 
agent  and  principal  always  has  been  that  the  agent  represents  the 
principal,  but  the  latter  is  responsible.  If  the  utility  investors 
were  merely  agents,  the  public  as  principal  would  be  responsible 
for  operation  and  management  with  resulting  profits  or  losses. 

Apparently  anticipating  the  future  claim  that  owners  of  prop- 
erty used  in  the  service  of  the  public  were  merely  agents,  the 
Federal  Court  years  ago  held  that  "the  property  now  under 
consideration  (of  the  gas  company)  is  as  much  the  private 
property  of  this  complainant  as  are  the  belongings  of  any 
private  citizen."^ 

The  fact  that  the  investor  is  compelled  to  assume  the  loss  in 
case  of  an  unprofitable  venture  must  be  considered  in  fixing  the 
fair  rate  of  return  of  profitable  utilities.  That  rates  cannot  be 
advanced  sufficiently  to  always  make  a  return  even  on  the  value 
of  the  physical  property  is  well  illustrated  by  the  decision  of  the 
Railroad  Commission  of  Oregon  in  the  Home  Telephone  & 
Telegraph  Company  case,  where  the  decision  says: 

"If  the  Commission  should  grant  authority  for  the  Home  Company 
to  increase  its  rate  to  the  extent  prayed  in  its  original  or  amended 
applications,  the  Home  Company  would  lose  a  large  number  of  sub- 
scribers who  are  now  patrons  of  its  exchanges,  without  gaining  any 
subscribers  in  place  thereof,  and  the  effect  would  be  to  decrease  the 
number  of  subscribers  connected,  to  diminish  the  value  of  service  to 
the  existing  subscribers  and  not  to  increase  the  gross  or  net  revenues 
of  the  company  in  proportion  with  the  increasing  rates.  It  is  not 
possible,  either  by  the  schedule  of  rates  applied  for  or  by  any  other 
schedule  which  the  commission  can  name,  to  yield  to  the  company  its 
present  and  duly  high  operating  expenses,  its  taxes,  depreciation  and 
any  substantial  return  upon  the  investment,  for  the  reason  that  any 
rates  which  would  yield  such  return  would  be  so  large  that  the  same 
would  exceed  the  value  of  the  service  to  the  patrons  and  would  be  un- 
reasonably high,  and  the  applicant  would  in  consequence  lose  so  many 
subscribers  that  neither  its  gross  nor  net  revenues  would  be  increased. "^ 

It  is  not  clear  by  what  process  an  impartial,  judicial  mind  can 
reason  that  properties  which  have  been  constructed  and  paid  for 

'  Consolidated  Gas  Co.  vs.  N.  Y.,  157  Fed.  854 
^  Commission  files  L.  U.  F.  52-54, 


FUNDAMENTALS  IN  VAIAJATION  58 

by  a  corporation  and  arc  used  in  serving  the  i)ul)lic  bcloii^r 
to  the  owners  as  "only  the  agent  of  the  pubHc  to  achniiiislcr 
their  use."  Certain  it  is  that  as  yet  the  majority  of  the  piiljlic 
and  the  higher  courts  are  not  prepared  to  decide  that  projxTty 
used  in  the  service  of  the  pubHc,  paid  for  by  the  money  of  private 
individuals,  belongs  to  the  public  and  administration  and  opera- 
tion are  the  only  rights  the  owners  have  in  such  property. 

"The  'trustee  theory,'  so-called,  assumes  that  there  exists  between 
the  public  and  every  railroad  carrier  the  relation  of  principal  and  agent, 
or  of  beneficiary  and  trustee.  No  such  relation  exists  and  the  assump- 
tion is  without  any  foundation  or  support." 


"The  right  of  governmental  authority  to  regulate  charges  of  those 
engaged  in  public  calling,  or  to  regulate  the  selling  price  of  commodities 
— in  the  cases  where  such  prices  may  be  regulated — rests  upon  the  power 
of  police  and  not  upon  ownership,  legal  or  equitable,  of  the  property. 

"There  is  no  support  in  judicial  decisions  for  the  trustee  theory,  or 
for  the  idea  that  the  power  to  regulate  in  any  manner  impairs  or  lessens 
the  title  or  ownership  of  him,  whose  charges  or  prices  are  subject  to 
regulation,  for  the  protection  of  the  public  against  extortion  and  unfair 
competition."^ 

1  Brief  filed  on  behalf  of  the  Railroad  Companies  represented  by  the  Presidents'  Con- 
ference Committee  before  the  Interstate  Commerce  Commission,  Sept.  1,  1915. 


CHAPTER  IV 
FAIR  VALUE  FOR  RATE-MAKING 

Principles  Involved. — There  has  been  a  steady  and  remarkable 
increase  in  the  use  of  utiUty  service  which  was  formerly  con- 
sidered more  or  less  a  luxury,  for  example,  the  general  use  of 
gas,  electric  light,  telephone,  street  car  service,  etc.  This  has 
continued  until  the  general  public,  now  looking  upon  such  ser- 
vice as  an  ordinary  necessity,  is  largely  interested  in  the  ques- 
tion of  charges  for  the  service  rendered  and  whether  or  not 
these  charges  are  fair  and  proper.  Owing  to  the  intricacies  of 
utility  management,  various  methods  of  accounting  and  the 
man}'  elements  entering  into  the  costs  of  service,  the  public 
generally  does  not  appreciate  the  varied  and  necessary  indirect 
expenses,  or  realize  that  many  charges  must  be  deferred  and, 
therefore,  are  not  apparent  in  the  current  weekly  or  monthly 
expenditures. 

The  public  is  primarily  interested  in  the  rendering  of  efficient, 
high-class  service  by  every  utility,  and  efficiency,  progressiveness 
and  permanency  cannot  be  obtained,  except  by  proper  recogni- 
tion and  allowance,  both  of  the  fair  value  of  the  investment  and 
fair  return  or  profits  thereon.  Merely,  "just"  reward  will  not 
usually  accomplish  these  results;  the  Constitution  of  the  United 
States  guarantees  "  nor  shall  private  property  be  taken  for  private 
use  without  just  compensation,"  but  mere  "just  compensation" 
without  something  additional  in  the  way  of  reward,  or  extra 
compensation,  does  not  always  insure  satisfactory  utility  service 
and  development.  This  is  recognized  by  the  courts  and  evi- 
denced by  the  commissions  in  allowance  by  the  latter  of  higher 
rates  of  return  than  the  mere  legal  requirement.  The  restriction 
of  reward  or  profit  to  that  securable  from  most  certain  and  con- 
servative business  ventures,  or  to  the  minimum  that  will  be 
allowed  by  the  Supreme  Court  in  order  to  avoid  confiscation, 
eliminates  all  incentive  to  risk  and  achievement  which  have 
always  been  the  spurs  to  individual  initiation,  invention  and 
enterprise,  that  are  the  boast  of  our  modern  civilization. 

54 


FAIR  VALVE  FOR  RATE-MAKING 

Public  regulating  bodies  usually  require  a  valuation  of  tlic 
physical  property  before  undertaking  rate-making.  While  this 
is  natural  and  very  often  necessary  in  order  to  base  conclusions 
upon  actual  figures,  it  is  an  interesting  fact  that  some  com- 
missions have  not  required  such  valuation  for  rate-making 
purposes  and  have  held  that  it  is  practicaljle  to  base  rates  upon 
information  obtained  from  annual  reports,  examination  of  books 
and  property,  and  a  knowledge  of  the  general  condition  of  the 
utility  being  considered.  In  fact,  mathematical  exactness  can- 
not be  followed  in  working  out  the  rates  to  be  charged  for 
services,  even  where  a  detailed  valuation  has  been  made;  the 
valuation  at  best  can  only  be  used  in  determining  an  approxi- 
mate amount  of  revenue  which  the  utility  is  entitled  to  receive 
as  a  fair  return  upon  its  property. 

We  hear  a  great  deal  about  rates  being  based  upon  the  "cost- 
of-service"  and  "  value-of-service "  theory,  but  these  bases  of 
rates  have  to  do  mainly  with  apportioning  the  tariffs  for  ser\dces 
rendered,  and  have  little  to  do,  ordinarily,  with  the  question 
of  total  revenue,  which  must  be  earned  in  order  to  yield  the 
utility  a  fair  return  upon  the  value  of  its  property.  In  fixing 
individual  tariffs  for  each  class  of  service,  the  maximum  antl 
minimum  to  be  allowed  are  considered,  but  the  total  revenue  from 
all  classes  of  service  at  the  different  tariffs  is  what  must  be 
considered  in  connection  with  the  value  entitled  to  fair  return. 

"Is  a  rate  unreasonable  because  it  does  not  pay  its  full  share  of 
taxes,  fixed  charges,  and  dividends?  ******  if  a  carrier  may 
raise  all  rates  to  a  basis  where  each  will  bear  its  share  of  cost,  including 
all  costs,  and  no  lower  rate  is  reasonable,  then  it  must  follow  that  all 
rates  are  unreasonable  which  yield  to  the  carrier  a  greater  return  than 
such  cost.  Under  such  theory  what  would  be  the  rate  on  tea  or  silks, 
or  high-priced  horses,  or  delicate  machines?  Is  there  to  be  no  classi- 
fication of  freight  excepting  upon  the  basis  of  cost  of  transportation 
plus  insurance  risk?  If  so  the  tariffs  of  every  railroad  in  the  United 
States  must  suffer  a  revolutionary  change.  In  all  classification  con- 
sideration must  be  given  to  what  may  be  termed  public  policy,  the 
advantage  to  the  community  of  having  some  kinds  of  freight  carried 
at  a  less  rate  than  other  kinds.  And  this  is  the  true  meaning  of  the 
phrase  'what  the  traffic  will  bear.'  It  expresses  the  consideration  that 
must  be  shown  by  the  traffic  manager  to  the  need  of  the  people  for 
certain  commodities.  He  accordingly  imposes  a  higher  rate  upon  what 
may  be  termed  luxuries  as  compared  with  that  imposed  upon  those 
articles  for  which  there  is  a  more   universal   demand.     He  also  gives 


56  VALUE  FOR  RATE-MAKING 

consideration  to  the  fact  that  the  rate  so  imposed  enters  into  the  ulti- 
mate price  to  the  consumer  to  but  a  small  degree  when  the  article  is 
one  of  high  value,  and  that  those  in  the  community  who  can  afford 
to  purchase  such  articles  can  well  afford  to  pay  a  rate  greater  than 
that  which  could  reasonably  be  imposed  upon  the  general  public  for 
commodities  of  common  use.  In  this  sense  what  the  traffic  will  bear 
and  the  value  of  the  service  are  analogous.  No  one  would  claim  that 
a  carrier  was  violating  its  duty  under  the  law  in  charging  three  times 
the  rate  upon  oriental  rugs  that  it  imposed  upon  cotton.  This  would 
not  be  undue  discrimination  as  between  commodities,  even  though  it 
costs  no  more  to  transport  the  rugs  than  it  did  the  cotton,  assuming 
both  to  be  carried  at  the  owner's  risk,  for  the  one  does  not  compete  with 
the  other,  and  one  may  reasonably  bear  a  higher  rate  than  the  other 
upon  public  grounds."^ 

Only  general  principles  that  should  be  adopted  in  deter- 
mining the  fair  value  of  the  property  used,  useful  or  reasonably 
necessary  for  the  service  being  rendered,  have  been  enunciated 
by  the  Supreme  Court,  Definite  and  determinate  rules  for 
valuing  property  have  been  established  by  some  of  the  lower 
courts,  as  well  as  State  commissions,  and  through  the  approval 
or  disapproval  of  these  decisions  and  rulings  the  Supreme  Court 
may  be  said  to  have  directly  determined  certain  proper  methods 
to  be  pursued  in  valuing  public  service  property. 

In  the  valuation  of  a  utility  property  in  Maine,  there  were 
referred  to  the  Supreme  Court  of  Maine,  under  a  statute  of  that 
state,  questions  to  be  answered  as  a  guide  to  the  appraisers  who 
were  engaged  in  valuing  the  property  of  the  water  company 
for  the  purpose  of  acquisition  by  a  water  district.  The  in- 
structions of  the  Court  are  so  illuminating  that  they  are  briefly 
summarized  as  follows: 

The  Court  held  that  the  actual  cost  of  the  plant,  with  a 
proper  allowance  for  depreciation,  was  competent  evidence  on 
the  question  of  value,  but  was  not  conclusive. 

That  the  earnings  of  the  company  might  be  considered,  but 
would  not  furnish  a  proper  test  of  value,  unless  found  to  have 
been  reasonable. 

That  the  quality  of  \hc  water  and  service  rendered  and  the 

'  Report  and  Order  of  the  Interstate  Commerce  Commission,  No.  1806,  pape  C23;  in  the 
matter  of  the  investiKation  and  suspension  of  advances  in  rates  for  the  transportation  of 
coal  by  the  Chesapeake  &  Ohio  Railway  Company,  Baltimore  &  Ohio  Railroad  Company, 
Norfolk  &  Western  Railway  Company,  the  Kanawha  &  Michigan  Railway  Company, 
and  their  connections. 


FAIR  VALUE  FOR  RATE-MAKING  57 

fitness  of  the  plant  to  meet  reasonable  requirements  were  material 
upon  the  question  of  present  value. 

That  the  appraisers  should  regard  the  franchises  of  the  com- 
pany as  entitling  them  to  continue  business  as  a  going  concern, 
but  subject  to  all  proper  legal  duties  governing  public  service 
corporations. 

That, 
"in  fixing  the  value  of  the  companies'  franchises,  the  appraisers  may 
give  such  regard  as  is  demanded  by  ample  and  fair  pubHc  policy  to 
the  past  investment,  risks  and  services  of  the  companies,  and  to  the 
reasonably  just  expectations  which  those  who  made  the  investment 
had  in  mind  when  so  investing. "^ 

That  past  misconduct  or  unfaithfulness  on  the  part  of  the 
companies  in  performing  their  duties  to  the  public,  as  by  charg- 
ing excessive  rates,  should  not  be  considered  on  the  question  of 
the  value  of  franchises. 

That  reproduction  cost  was  properly  to  be  considered,  but  that 
such  cost  was  not  conclusive  because  it  left  out  of  consideration 
the  element  of  value  as  a  completed  structure,  connected  with 
buildings  prepared  for  use,  and  the  element  that  the  company 
was  a  going  concern,  and  that  these  latter  elements  were  to  be 
taken  into  consideration. 

That, 
"in  determining  the  amount  to  be  added  to  structure  value,  in  consid- 
eration of  the  fact  that  the  system  is  a  going  concern,  the  appraisers 
should  consider,  among  other  things,  the  present  efficiency  of  the 
system,  the  length  of  time  necessary  to  construct  the  same  de  novo, 
the  time  and  cost  needed  after  construction  to  develop  such  new  sys- 
tem to  the  level  of  the  present  one  in  respect  to  business  and  income, 
and  the  added  net  income  and  profits,  if  any,  which  by  its  acquire- 
ment as  such  going  concern  would  accrue  to  the  purchaser  during  the 
time  required  for  such  new  construction  for  and  such  development  of 
business  and  income."^ 

The  two  fundamental  facts  to  be  established  in  rate-making 
are  the  present  value  of  the  property  being  considered  and  the 
rate  of  return  to  be  allowed  thereon.  To  reach  fair  and  equitable 
conclusions  as  to  these  facts  to  be  established  involves  difficulties 
not  alone  because  the  facts  must  be  fixed  as  a  matter  of  judgment, 
but  because  the  subject  must  be  approached  in  fairness,  equity 
and  without  prejudice  to  the  conflicting  interests  involved. 

1  Kennebec  Water  District  vs.  City  of  Waterville,  54  Atl.  (Me.)  6. 


58  VALUE  FOR  RATE-MAKING 

In  attempting  to  follow  the  legal  method  of  making  an 
appraisal  to  arrive  at  the  fair  value  for  rate-fixing  purposes, 
original  investment  or  cost  must  usually  give  way  to  reproduc- 
tion value,  unless  precluded  by  State  laws  or  other  contractural 
relations.  It  sometimes  happens  that  rules  and  regulations  fixed 
by  legislatures  and  commissions  or  court  decisions  render  futile 
the  fixing  of  what  is  really  fair  present  value,  but  that  by  no 
means  prevents  the  ascertainment  and  presentation  of  the  basis 
of  fair  value,  although  such  basis  may  be  ultimately  discarded. 

In  rate-fixing,  it  must  be  constantly  borne  in  mind  that  the 
problems  to  be  solved  are  the  fair  revenue  allowed  a  particular 
property  on  the  basis  of  its  value  at  the  present  time.  This 
value  cannot  be  ascertained  merely  by  reference  to  its  past 
history,  even  as  to  earnings  or  cost,  unless  such  limits  were  fixed 
at  the  time  of  its  creation.  Whether  earnings  were  so  small  in 
the  past  as  not  to  have  allowed  ample  return  to  the  owners,  or 
whether  the  earnings  have  been  sufficiently  great  to  permit 
payment  of  profits,  as  well  as  additions  to  and  enlargements  of 
the  property  itself,  cannot  be  used  to  justify  the  use  of  any 
fictitious  value  or  artificial  rate  of  return  in  disregard  of  the  real 
present  value  and  fair  return  as  between  the  owners  and  the 
rate  payers.  In  attempting  to  ascertain  the  present  value  of  the 
property,  the  appraiser  must  approach  the  question  without  bias 
of  favoritism,  considering  only  what  a  fair,  business-like  invest- 
ment under  existing  circumstances,  with  normal  conditions  of 
construction  and  financing,  would  be  required.  The  same  funda- 
mental principles  must  apply  regardless  of  whether  the  property 
might  be  owned  by  an  individual,  a  corporation,  a  municipality 
or  the  Federal  Government,  although  the  cost  might  be,  and  the 
rate  of  return  allowed  certainly  would  be,  different  with  respect 
to  the  four  different  classes  of  owners  indicated  for  purposes  of 
illustration. 

The  valuation  of  public  utilities  for  the  purpose  of  rate-making 
requires  the  knowledge  and  skill  of  engineers,  real  estate  ap- 
praisers, accountants  and  economists,  financiers  and  lawyers. 
Otherwise,  the  proper  importance  of  the  many  elements  of  the 
value  going  to  make  up  the  total  fair  value  of  the  entire  property 
will  not  be  appreciated'  and  duly  recognized.  The  early  at- 
tempts of  accoimtants  and  lawyers  to  demonstrate  to  courts 
the  value  of  property  to  be  used  as  a  basis  for  sale,  condemna- 
tion, or  rate-making  resulted  in  frequent   failure.     Later,   the 


FAIR  VALUE  FOR  RATE-MAKING  59 

introduction  of  the  engineer,  who  had  had  experience  in  opera- 
tion as  well  as  construction  work,  emphasized  the  relation  of 
the  physical  to  certain  non-physical  elements,  hut  there  was 
still  lacking  knowledge  and  recognition  of  many  of  the  intangil^le 
elements,  to  demonstrate  the  causes  and  value  of  which  were 
required  the  services  of  those  expert  in  utility  operation,  in 
economics  and  finance. 

"When  *  *  *  appraisals  first  came  to  be  used  as  a  basis  for  rate  regu- 
lation all,  except  engineers,  regarded  an  appraisal  as  being  soniewliat 
analogous  to  a  merchant's  inventory  of  stock  on  hand — a  very  simj)le, 
though  often  laborious,  process.  Gradually  it  has  become  evident,  even 
to  non-technical  men,  that  an  appraisal  for  rate-making  purposes  is  ex- 
ceedingly technical  and  complex.  When  it  is  realized,  also,  that  rate- 
making  based  on  cost  is  even  more  technical  than  appraising  a  property, 
we  shall  have  an  end  to  the  'hot  air'  testimony  of  rate  experts  wlio  are 
experts  only  in  fixing  rates  as  high  'as  the  traffic  will  bear.' 

Appraisal  and  rate  engineering  has  already  become  one  of  the  many 
branches  of  engineering.  The  engineering  specialist  in  this  line  should 
be  primarily  a  logician,  skilled  in  the  use  of  language  and  in  the  .science 
of  reasoning.  He  should  be  thoroughly  acquainted  with  tlie  general 
principles  of  economics  and  particularly  with  the  principles  of  engineer- 
ing economics.  He  should  be  well  informed  as  to  the  decisions  of  State 
and  Federal  rate-regulating  commissions,  as  well  as  court  decisions 
bearing  on  valuations  and  rates.  He  should  be  personally  acquainted 
with  specialists  in  many  lines,  so  that  he  may  select  men  competent 
to  give  any  desired  information.  He  should  be  thoroughly  grounded, 
not  only  in  the  principles  of  accounting,  but  in  the  mechanical  details 
of  public  utility  accounting.  He  should  be  an  incessant  student  of  the 
new  phases  of  his  specialty  and  of  unit  costs  of  construction  and  operation. 
Executive  ability  is  also  essential  to  him,  but  need  not  be  of  as  high 
an  order  as  that  required  of  one  who  is  constantly  directing  large  enter- 
prises. It  is  needless,  perhaps,  to  add  that  his  character  should  be  such 
that  he  would  make  an  impartial  judge.  Obviously,  no  man  can  attain 
the  ideal  in  this  or  in  any  other  branch  of  engineering;  but,  at  least, 
those  who  employ  appraisal  and  rate  engineers  should  aim  to  secure 
men  who  are  idealists  rather  than  opportunists,  for  this  is  not  a  profes- 
sion where  mere  advocates  will  survive."' 

In  ascertaining  the  value  of  any  property,  new  or  old,  the 
valuation  of  all  of  its  physical  or  structural  property  is  generally 
conceded  as  the  first  step  proper  to  be  taken.     While  agreement 

»  By  H.  p.  Gillete,  Discussion  on  Physical  Valuation  of  Railroads,  Proceedings  of  tho 
American  Society  of  Civil  Engineers,  Vol.  XXXIX,  No.  8. 


60  VALUE  FOR  RATE-MAKING 

may  be  had  as  to  the  inventory  or  Hst  of  items  going  to  make  up 
the  total  property,  differences  begin  to  arise  as  soon  as  assign- 
ment of  value  in  dollars  begins.  This  difference  widens  as  per- 
centages or  estimated  amounts  are  added  for  allowances,  gen- 
erally conceded  necessary,  to  cover  items  too  small  to  list 
separately,  incidentals,  omission  due  to  inaccuracy,  unrecognized 
contingencies  of  construction,  engineering,  administration  ex- 
penses, cost  of  contractors'  services  and  expenses,  insurance,  taxes, 
interest,  cost  of  raising  money,  reward  to  the  originators  of  the 
enterprise  for  services  and  expenditures  before  construction 
began,  and  other  so-called  overhead  or  intangible  costs.  Then 
there  are  the  further  differences  as  to  the  proper  treatment  of 
certain  items  such  as  real  estate,  the  cost  of  developing  the 
revenue  as  distinct  from  building  the  physical  property,  usually 
called  "going  value,"  the  necessary  allowances  for  working 
capital,  and  finally  the  application  of  depreciation,  in  order  to 
obtain  the  so-called  depreciated  present  value. 

Even  those  advocates  of  the  theory  that  only  physical  values, 
theoretically  depreciated,  should  be  considered  in  rate-making 
generally  admit  the  fact  that  in  addition  to  the  actual  net  cost 
of  the  structural  property  there  should  be  added  certain  allow- 
ances, more  or  less  liberal,  for  all  of  those  items  mentioned 
above  except  going  value.  They  may  hold  that  real  estate 
should  be  taken  at  its  original  cost,  that  working  capital  consists 
only  of  supplies  and  going  value  has  no  existence  but,  otherwise, 
they  admit  that  after  depreciation  has  been  deducted  from 
structural  value,  built  upon  such  meager  basis  as  here  indicated, 
the  remainder  is  the  fair  present  value  of  any  utility  property. 

Law  and  Method. — In  considering  value  for  purposes  of  rate- 
making,  the  subject  may  be  approached  from  two  distinct  and, 
in  some  respects,  diametrically  opposed  directions,  one  from  a 
knowledge  and  intent  to  follow  precisely  the  principles  and  pre- 
cepts laid  down  in  the  law,  based  on  court  decisions,  the  other 
from  an  independent  standpoint,  regardless  of  court  rulings  but 
with  a  view  to  arriving  at  a  fair  and  equitable  value  based  on  a 
knowledge  of  the  practicable  conditions  under  which  construc- 
tion and  operation  of  public  utilities  may  be  carried  out,  an  appre- 
ciation of  the  laws  of  political  economy,  a  knowledge  of  finance 
and  experience  in  valuation  work.  It  is  recognized  by  the  legal 
profession  that  a  decision  may  be  technically  correct  but  will  work 
injustice.     The  courts  versed  in  law  rather  than  engineering  have. 


FAIR  VALUE  FOR  RATE-MAKING  (51 

at  times,  possibly  from  lack  of  proper  evidence,  rendered  decisions 
that  make  the  law  contrary  to  what  it  is  possible  and  practicable 
to  carry  out  in  practice.  On  the  other  hand,  determinations  of 
value  that  are  made  without  proper  consideration  of  precetlencc; 
and  regard  for  previous  decisions  of  the  courts  render  the  con- 
clusions liable  to  be  set  aside  in  case  appeal  is  made  to  the  hiw. 
Therefore,  the  usual  course  pursued  by  those  endeavorinji;  to  make; 
physical  facts  and  human  possibilities  conform  to  legal  re(iuire- 
ments  is,  with  the  use  of  knowledge  obtained  through  tlie  con- 
struction and  operation  of  utility  property,  and  having  in  mind 
legal  precedence,  to  determine  value  upon  principles  of  etpiity 
and  justice,  without  violating  the  rules  of  law. 

The  general  rule  accepted  by  the  investing  public  is  that  the 
present  fair  value  of  property  is  determined  from  a  considcMation 
of  what  it  is  fairly  earning  and  what  it  may  be  fairly  expected 
and  allowed  to  earn  in  the  future.  This  rule,  by  and  far,  applies 
to  property  regardless  of  whether  it  is  owned  by  an  individual, 
an  industrial  corporation,  or  a  public  utility.  But,  of  course, 
tariffs  charged  for  public  utility  service  cannot  be  based  on  a  value 
determined  by  capitalizing  net  earnings.  Since  the  tariffs  them- 
selves determine  the  earnings,  equity,  common  sense,  and  usually 
the  courts  indicate  that  the  tariffs  fixed  must  permit  the  utility 
property  to  earn  a  fair  return  upon  its  to-day's  value,  not  upon 
what  it  may  have  cost  originally  or  be  prospectively  worth  in 
the  future.  Moreover,  the  tariffs,  that  is,  the  earnings,  must  be 
such  as  will  maintain  the  fair  value  of  the  property,  without  tend- 
ing to  increase  or  depress  said  value,  on  the  basis  of  capitalizing 
net  earnings.  In  order  to  determine  and  fix  the  proper  tariffs 
and  earnings,  the  value  of  the  property  itself  must  first  be 
established. 

Investment  not  Value. — The  theory  that  investment  or  original 
cost  is  value,  is  based  upon  the  thought  that  the  investor  in  a 
public  utility  should  have  his  investment  protected  by  the 
pubhc,  and  receive  a  fair  return  thereon  from  the  public,  re- 
gardless of  whether  the  value  of  his  investment  increases  or 
decreases.  The  argument  is  that  if  from  the  beginning  there 
is  earned  upon  the  money  actually  expended  by  the  owner  of  a 
property  what  is  now  considered  a  fair  return,  rates  fixed  upon 
the  cost  basis  are  equitable,  allowance  being  made  for  expendi- 
tures covering  deficiencies  usually  occurring  in  the  early  days 
of  a  corporation's  existence  by  recognizing  such  deficits  as  a  part 


62  VALUE  FOR  KATE-MAKING 

of  the  invest mciit  or  compensating  for  them  in  fixing  the  rate  of 
return.  This  theory  holds  that  the  owners  of  property  devoted 
to  the  pubUc  use,  by  reason  of  the  special  privileges  and  obliga- 
tions, are  entitled  to  only  a  reasonable  return  upon  the  cash  ex- 
pended, that  is,  upon  the  "cost,"  and  should  not  be  allowed  to 
share  either  in  any  increment  in  land  or  other  property  values, 
or  in  profits  larger  than  a  "fair  return,"  although  perhaps  the 
higher  figures  are  the  result  of  unusual  foresight,  business  abil- 
ity, or  exceptional  opportunity.  The  "original  cost"  theory  is 
usually  held  to  be  applicable  to  those  utilities  which  have  pros- 
pered, or  the  property  of  which  has  largely  increased  in  value  so 
that  the  owners  have  had  more  than  a  so-called  "fair  return" — 
usually  held  to  be  from  6  to  8  per  cent. — upon  their  investment. 
Risk  to  investment  at  the  time  of  the  original  expenditure  by 
reason  of  surrounding  local  conditions,  uncertainty  as  to  success- 
ful coordination  of  the  physical  property,  development  and  im- 
provements in  the  art,  losses  arising  from  competition,  political 
agitation,  unusual  accidents,  errors  of  managements,  strikes,  the 
time,  energy,  ability  and  initiative  of  the  promoters,  not  usually 
paid  for  in  money  but  in  stock,  are  most  difficult  to  understand, 
appreciate  and  evaluate  years  afterward  when  an  enterprise  has 
proven  a  success,  and  hence  are  almost  always  minimized  and 
under-valued.  Consequently  the  "original  cost"  theory  does 
not  appeal  to  the  owners  of  successful  utilities  and  has  never 
proposed  to  be  applied,  even  by  its  most  ardent  advocates,  in 
fixing  the  rates  to  be  paid  a  non-paying  or  abandoned  proposi- 
tion. The  most  liberal  use  of  the  theory  has  been  to  recognize 
certain  deficits  for  an  arbitrarily  limited  period  only,  imme- 
diately after  a  corporation  starts  business,  which  limited  def- 
icits are  taken  as  the  going  value  of  the  property;  but  this  is 
in  no  sense  a  practical  application  throughout  its  corporate 
existence  of  the  "cost"  theory  to  an  unsuccessful,  unprofitable 
utility  which  may  be  serving  the  public  just  as  faithfully  as 
another  more  profitable  corporation. 

The  attempt  to  apply  the  "original  cost"  theory  under  present- 
day  regulation  assumes  that  the  corporation  which  has  been  in 
operation  for  years,  although  fixing  its  tariffs  with  the  tacit  and 
ofttimes  expressed  approval  of  State  or  municipal  authorities 
and  supplying  generally  the  requirements  of  the  public,  has  been 
making  undue  and  unfairly  large  profits.  Such  assumption  as 
to  profits  is  frequently  entirely  unwarranted  and  must  be  recog- 


FAIR  VALUE  FOR  RATE-MAKING  63 

nized  as  an  attempt  to  take  from  the  present  owners  of  a  utility 
a  part  of  its  present  value.  Previous  owners  may  have  earned 
what  are  now  considered  too  great  profits,  but  as  the  public  regu- 
lating bodies  have  not  heretofore  felt  called  upon  to  reduce  these 
profits,  although  always  having  the  power  to  do  so,  on  what  fair 
grounds  can  those  former  profits  now  fairly  ])e  readjusted  to 
present-day  standards,  or  a  part  of  the  earlier  large  earning,  that 
may  have  been  reinvested  in  the  plant,  claimed  as  the  property 
of  the  pubHc?  Evidently  the  earlier  profits  were  not  considered 
exorbitant  in  those  days  by  those  best  able  to  judge.  Utility 
investments  are  now  often  made  upon  the  understanding  and 
agreement  that  the  owners  are  to  be  allowed  only  a  fair  maxi- 
mum return,  regardless  of  the  financial  failure  or  success  of  the 
enterprise.  Capital  can  be  interested  if  the  rate  paid  is  high 
enough,  but  until  recently  there  has  been  no  understanding  or 
notification  that  such  return  would  be  from  6  to  8  per  cent,  as 
a  maximum  for  the  successful  corporations,  with  the  unsuccessful 
ones  standing  their  own  losses. 

While  the  courts  recognize  hona  fide  investment  as  one  of  the 
important  elements  to  be  given  due  weight  in  ascertaining  values, 
they  are  practically  in  unanimous  agreement  that  the  only  final 
basis  upon  which  fair  returns  must  be  allowed  is  fair  present  value. 
Nevertheless,  some  individuals  and  public  service  commissions 
still  maintain  that  cost,  namely,  the  original,  cost  or  cash,  invest- 
ment in  the  utility  property  is  the  only  proper  basis  upon  which 
to  determine  rates  and  allow  returns.  The  attempt  to  base 
rates  merely  upon  the  original  cost  of  investment  results  not  only 
in  unfairness  to  the  present  owners,  but  under  many  conditions 
will  lead  to  absurd  results,  because  value  cannot  be  fixed  without 
some  regard  to  net  earnings.  The  cost  of  a  plant  in  the  middle 
of  the  Sahara  Desert,  without  ability  to  earn,  would  not  fix  its 
value.  A  recent  appraisal  disclosed  the  fact  that  an  old  type  of 
dynamo,  inefficient  and  out  of  date,  was  worth  more  by  reason 
of  the  excessive  amount  of  copper  it  contained,  than  the  cost 
new  of  a  modern  machine  capable  of  delivering  the  same  out- 
put efficiently.  Would  the  adherents  of  the  investment  theory 
argue  that  the  public  should  pay  a  return,  in  addition  to  the 
higher  operating  costs  for  energy  developed  by  the  obsolete 
dynamo? 

The  investment  or  cost  principle  is  eminently  fair  and  beyond 
criticism,  provided  the  investor  originally  places  his  money  upon 


64  VALUE  FOR  RATE-MAKING 

that  understanding,  but  it  is  unfair  and  improper  to  require  an 
investor  to  accept  such  terms  when  he  has  put  his  money  into 
an  enterprise  upon  the  understanding  that  he  is  taking  the  risk 
of  loss  or  gain  in  his  principal,  with  the  concomitant  gains  or 
losses  in  earnings. 

"Again  upon  the  same  point  it  should  be  said  that  those  who  engage 
in  a  public  service  cannot  be  put  upon  quite  the  same  level  as  those  who 
make  mere  investments.  They  are  not  like  the  depositors  in  a  savings 
bank,  whose  right  to  draw  out  is  limited  to  precisely  what  they  have  put 
in  with  its  earnings.  They  are,  on  the  contrary,  engaged  in  a  business, 
with  the  ordinary  incidents  of  a  business,  with  some  of  the  hazards 
and  some  of  the  hopes  of  a  business.  To  be  successful  they  must  be 
wise  and  prudent,  thrifty  and  energetic.  These  virtues,  if  they  have 
them,  they  impress  upon  the  property,  making  it  more  valuable  than  it 
otherwise  would  have  been.  Is  it  to  be  said,  that  they  can  have  no 
return  for  skill  and  good  management?     We  do  not  think  so."^ 

Public  regulation  is  applying  the  investment  theory  to  capital 
being  added  to  corporations  already  under  public  control  or  to 
those  enterprises  which  are  being  newly  inaugurated  without 
much  criticism  or  charges  of  unfairness,  because  investment  and 
present  values  are  kept  practically  equal. 

As  a  matter  of  fact,  the  repeated  rulings  of  the  various  courts, 
including  the  Supreme  Court  of  the  United  States,  show  quite 
clearly  that  original  investment  value  is  not  the  value  of  existing 
property.  Without  attempting  to  quote  a  long  list  of  judicial 
decisions  in  this  matter,  some  of  which  have  been  quoted  in 
preceding  pages,  it  may  be  pertinent  to  refer  to  the  explicit 
language  of  the  Supreme  Court  in  a  few  instances,  as  for  example 
in  the  case  of  the  San  Diego  Water  Company,  where  the  Court 
said: 

"The  contention  of  the  appellant  in  the  present  case  is  that  in  as- 
certaining what  are  just  rates,  the  Court  should  take  into  considera- 
tion the  cost  of  its  plant.  The  basis  of  calculation  suggested  by  the 
appellant  is,  however,  defective  in  not  requiring  the  real  value  of  the 
property  and  the  fair  value  in  themselves  of  the  services  rendered  to 
be  taken  into  consideration.  What  the  company  is  entitled  to  demand, 
in  order  that  it  may  have  just  compensation,  is  a  fair  return  upon  the 
reasonable  value  of  the  property  at  the  time  it  is  being  used  for  the 
public. "■- 

'  Brunswick  &  Topshaw  Water  District  vs.  Maine  Water  Co.,  99  Maine  379. 
"San  DicKo  Land  &  Town  Co.      National  City,  174  U.  S.  757. 


FAIR  VALUE  FOR  RATE-MAKING  65 

In  the  case  of  the  ConsoHdated  Gas  Company  tlie  Court  said: 

"There  must  be  a  fair  return  upon  the  reasonable  vahie  of  the  property 
at  the  time  it  is  being  used  for  tlio  pubHc."' 

In  the  more  recent  Minnesota  rate  cases  the  Supreme  Court 
said: 

"It  is  clear  that  in  ascertaining  the  present  value,  we  are  not  limited 
to  the  consideration  of  the  actual  investment.  The  property  is  held  in 
private  ownership  and  it  is  that  property,  and  not  the  original  cost  of 
it,  of  which  the  owner  may  not  be  deprived  without  due  process  of  hiw."- 

In  another  railway  case  the  Supreme  Court  said: 

"Will  it  be  said  that  the  taxation  must  be  based  simply  on  the  cost, 
when  never  was  it  held  that  the  cost  of  the  thing  was  the  test  of  its 
value?"' 

"We  hold,  however,  that  the  basis  of  all  calculations  as  to  the  rea- 
sonableness of  rates  to  be  charged  by  a  corporation  maintaining  a 
highway  under  legislative  sanction  must  be  the  fair  value  of  the  property 
being  used  by  it  for  the  convenience  of  the  public."'' 

Aside  from  the  convincing  language  of  the  courts,  it  is  very 
frequently  found  in  practice  impossible  to  ascertain  from  cor- 
poration records  the  investment  value  of  the  property.  This 
condition  results  not  always  from  intention  to  conceal  such 
facts,  but  by  reason  of  the  earlier  methods  of  keeping  corporation 
records,  and  the  fact  that  utilities,  at  least  those  of  large  size, 
are  usually  the  result  of  sale,  consolidation  and  amalgamation 
so  that  the  records  of  the  subsidiary  companies  would  not  pass 
to  the  existing  corporation,  and  have  been  lost  or  destroyed  in 
the  ordinary  course  of  business.  Those  advocates  of  the  uni- 
versal application  of  the  investment  theory  apparently  over- 
look this  very  important  actual  condition  of  affairs,  namely, 
the  inability  to  get  at  or  produce  records. 

Under  existing  public  regulation  methods,  a  most  satisfactory 
basis  of  valuation  for  a  recently  created  property  is  th(^  actual 
cost,  excluding  any  unreasonable,  extravagant  or  untair  ex- 
penditures. While  on  the  one  hand  the  public  should  not  be  re- 
quired to  pay  a  return  upon  injudicious  or  extravagant  expendi- 

1  Wilcox  et  al  vs.  Consolidated  Gas  Co.,  212  U.  S.  19. 

2  Minnesota  Rate  Cases  230  U.  S.  352. 

^  C.  C.  C.  &  St.  L.  Rwy.  Co.  vs.  Backus,  154  U.  S.  446. 
*  Smyth  vs.  Ames,  169  U.  S.  546. 
5 


66  VALUE  FOR  RATE-MAKING 

tures,  on  the  other  hand,  all  investments  that  have  been  honestly 
made  in  preparing  to  render  the  service,  must  be  included  in  the 
value  of  the  property.  T  ^se  costs  relate  not  only  to  the 
structural  property,  but  include  all  those  expenditures  for  in- 
tangible items,  or  overhead  charges,  such  as  administration  and 
organization  expenses,  cost  of  promotion,  incidentals,  en- 
gineering, interest  and  taxes  during  construction,  etc.,  as  well 
as  going  value,  or  the  cost  of  developing  the  business  and  secur- 
ing the  revenue. 

It  would,  of  course,  be  unfair  to  apply  the  investment  theory 
to  certain  utilities  and  apply  another  theory,  which  would  rela- 
tively increase  values,  to  the  other  utilities.  For  example,  in 
the  Interstate  Commerce  railway  valuations  now  being  made, 
there  are  available  records  of  all  more  recent  construction,  so 
that  investment  cost  can  be  ascertained,  but  with  regard  to 
much  of  the  property  no  records  are  obtainable,  so  that  some 
other  method  must  be  used  in  fixing  values.  It  would  evidently 
be  inconsistent  and  unfair  to  apply  different  methods  to  the 
same  property,  or  one  method  to  a  railroad  which  had  records 
available  and  another  method  to  a  railroad  which  had  no  records. 
Therefore,  some  more  uniformly  applicable  method  than  the  in- 
vestment theory  must  be  used  in  determining  values. 

Basis  of  Value. — The  highest  courts  have,  beyond  contro- 
versy, settled  the  fact  that  the  owner  of  property  devoted  to, 
or  reasonably  necessary  for,  the  service  of  the  public  is  at  least 
entitled  to  a  fair  return  upon  the  fair  value  of  such  property. 
This  conclusion  of  the  courts  is  the  extreme  minimum  allowable 
under  the  well-known  clause  of  the  Fourteenth  Amendment  to 
the  Federal  Constitution  prohi})iting  confiscation  of  private 
property.  Such  conclusion  docs  not  necessarily  preclude  the 
principle  that  aside  and  in  addition  to  return  on  property  the 
owner  may  be  entitled  to  remuneration  for  efhciencj^  or  the 
high  class  of  service  rendered,  so  that  equitable  rate-regulation 
should  consider  both  property  and  service.  The  power  to  regu- 
late rates  is  primarily  based  on  the  principle  that  justice  is  to 
be  done  both  the  owner  of  the  property  and  the  customers 
served  thereby,  but  before  fixing  the  tariffs  for  particular  service 
rendered  the  consumers,  there  must  be  determined  proper  gross 
revenues  which  shall  be  sufficient  to  at  least  afford  a  fair  return 
on  the  value  of  the  property  used,  in  addition  to  a  reward  for 
especial  services — if  any — and  operating  expenses,  including  de- 


FAIR  VALUE  FOR  RATE-MAKING  (;; 

prociatioii.  (Consequently,  even  admitting  minor  diiTerenees  in 
opinion  as  to  the  proper  basis  for  rate-making,  practically  all 
agree  that  the  value  of  the  physical  property  used  in  the  service 
is  one  of  the  most  essential  facts  to  be  known  before  rate-making 
can  proceed.  Even  though  the  character  of  service  is  excluded 
from  consideration  and  it  is  held  that  rates  are  to  be  determined 
upon  the  cost  of  the  service,  there  are  instances  where,  even 
under  such  theory,  rates  cannot  be  made  sufficiently  high  to 
furnish  an  adequate  return  upon  the  value  of  the  property, 
because  of  the  relatively  large  investment,  high  operating 
expense  or  by  reason  of  competition  or  other  unfavorable  cir- 
cumstances. Such  cases,  however,  may  be  considered  rather 
exceptional  and  abnormal,  so  that  the  methods  of  determining 
value  and  fixing  rates,  generally  applicable,  will  not  apply. 

While  the  broad  principles  to  be  used  in  determining  fair  value 
are  recognized,  the  detailed  method  of  determining  such  value  is 
more  or  less  vague  and  the  subject  of  much  controversy.  And, 
yet,  uniformity  of  methods  of  valuation  are  really  essential,  if 
satisfactory  relations  between  the  utilities  and  the  public  are 
to  be  obtained  and  fairness  and  justice  rendered  to  both. 

As  yet,  public  authorities,  particularly  the  Supreme  Court, 
have  failed  to  indicate  definite  and  complete  rules  to  be  applied 
in  determining  the  fair  value  of  utility  property.  Nevertheless, 
the  higher  courts  have  indicated  the  general  principles  which 
may  be  used  as  guides  in  determining  the  fair  value  to  be  es- 
tablished, in  any  particular  case.     They  are: 

First. — The  original  cost  of  the  property  of  which  the  fair  value 
is  being  determined. 

Second. — The  cost  of  reproducing  new  at  the  present  time, 
with  current  prices,  the  existing  property. 

Third. — An  estimate  of  the  loss  in  value,  the  depreciation,  if 
any,  that  has  resulted  to  the  property  in  rendering  service. 

Fourth. — The  amount  and  market  value  of  the  stock  and 
bonds  outstanding,  including  both  the  original  and  subsequent 
issues. 

Fijth. — The  gross  revenue  and  operating  expenses. 

Sixth. — The  worth  of  the  service  rendered. 

While  all  of  the  above  elements  mentioned  by  the  courts  are 
to  be  considered  in  determining  value  in  any  given  case,  the 
relative  weight  and  importance  of  any  given  element  must  be 
determined  by  the  authority  fixing  value.     These  views  are  in 


68  VALUE  FOR  RATE-MAKING 

accordance  with  court  rulings,  as  clearly  indicated  in  the  National 
Water-works  Company  case,  where  the  Court  said: 

"We  are  not  satisfied  that  either  method,  by  itself,  will  show  that 
which,  under  all  circumstances,  can  be  adjudged  'the  fair  and  equitable 
value.'  Capitalization  of  the  earnings  will  not,  because  that  implies  a 
continuance  of  earnings,  and  a  continuance  of  earnings  rests  upon  a 
franchise  to  operate  the  water-works.  The  original  cost  of  the  con- 
struction cannot  control,  for  'original  cost'  and  'present  value'  are  not 
equivalent  terms.  Nor  would  the  mere  cost  of  reproducing  the  water- 
works plant  be  a  fair  test,  because  that  does  not  take  into  account  the 
value  which  flows  from  the  established  connections  between  the  pipes 
and  the  buildings  of  the  city.  It  is  obvious  that  the  mere  cost  of  pur- 
chasing the  land,  constructing  the  buildings,  putting  in  the  machinery, 
and  laying  the  pipes  in  the  streets — in  other  words,  the  cost  of  repro- 
duction— does  not  give  the  value  of  the  property  as  it  is  to-day.  A 
completed  system  of  water-works,  such  as  the  company  has,  without  a 
single  connection  between  the  pipes  in  the  streets  and  the  buildings  of 
the  city,  would  be  a  property  of  much  less  value  than  that  system  con- 
nected, as  it  is,  with  so  many  buildings,  and  earning,  in  consequence 
thereof,  the  money  which  it  does  earn.  The  fact  that  it  is  a  system  in 
operation,  not  only  with  a  capacity  to  supply  the  city,  but  actually 
supplying  many  buildings  in  the  city — not  only  with  a  capacity  to 
earn,  but  actually  earning — makes  it  true  that  'the  fair  and  equitable 
value'  is  something  in  excess  of  the  cost  of  reproduction.  The  fact 
that  the  company  does  not  own  the  connections  between  the  pipes  in 
the  streets  and  the  buildings — such  connection  being  the  property  of 
the  individual  property  owners — does  not  mitigate  against  the  proposi- 
tion stated,  for  who  would  care  to  buy,  or  at  least  give  a  large  price  for, 
a  water-works  system  without  a  single  connection  between  the  pipes 
in  the  streets  and  the  buildings  adjacent?  Such  a  sj'^stem  would  be  a 
dead  structure,  rather  than  a  living  and  going  business.  The  additional 
value  created  by  the  fact  of  many  connections  with  buildings,  with 
actual  supply  and  actual  earnings,  is  not  represented  by  the  mere  cost 
of  making  such  connections.  Such  connections  arc  not  compulsory, 
but  depend  upon  the  will  of  the  property  owners,  and  are  secured  onlj' 
by  efforts  on  the  part  of  the  owners  of  the  water-works,  and  induce- 
ments held  out  therefor.  The  city,  by  this  purchase,  steps  into 
possession  of  a  water-works  plant — not  merely  a  completed  system 
for  Ijringing  water  to  the  city,  and  distributing  it  through  pipes  placed 
in  the  streets,  but  a  system  already  earning  a  large  income  by  virtue 
of  having  secured  connections  between  the  pipes  in  the  streets  and  a 
multitude  of  private  buildings.  It  steps  into  possession  of  a  property 
wliich  not  only  has  the  ability  to  earn,  but  is  in  fact  earning.     It  should 


FAIR  VALVE  FOR  RATE-MAKIXC  m 

pay,  therefore,  not  merely  the  vakie  of  a  system  wliicli  iiiij^lit  he  ih.'kIc 
to  earn,  but  that  of  a  system  which  does  earn."^ 

Some  discussion  of  the  merits  and  weight  of  the  several 
elements  to  be  considered,  in  accordance  with  the  instructions  of 
the  courts,  has  been  had  in  preceding  pages,  others  will  be  dis- 
cussed more  fully  hereafter,  but  it  should  be  here  recognized  Ihat 
value  is  the  result  of  judgment  and  cannot  be  mathematically 
deduced  from  a  consideration  of  an}^  one  or  all  of  the  six  elements 
specified  above.  The  six  elements  of  cost  may  be  considered  as 
pedestals  supporting  the  platform  on  which  rests  the  determined 
value.  Which  one  of  the  pedestals,  or  whether  more  than  one, 
shall  carry  the  principal  part  of  the  weight  in  arriving  at  the 
value  fixed,  may  be  determined  in  each  case,  but  as  a  rule  the 
second  and  third  elements  named  are  primarily,  and  the  fifth 
and  sixth  elements  secondarily  of  greatest  importance  in  every 
valuation.  The  reasons  why  original  cost  is  not  of  primary 
importance  in  fixing  the  value  of  utility  property  that  was  created 
before  the  present  era  of  public  service  regulation,  have  already 
been  discussed  in  preceding  pages.  The  value  of  outstanding 
stocks  and  bonds,  or  other  securities,  cannot  usually  be  urged  or 
accepted  as  the  proper  basis  of  fixing  present  value  for  the 
reason  that  some  utilities  have  not  issued  securities  equal  in 
value  to  their  property,  while  others  have  issued  too  large 
amounts  and  have  outstanding  "watered"  securities. 

The  Honorable  F.  W.  Stevens,  formerly  chairman  of  the 
Public  Service  Commission  of  New  York,  Second  District,  very 
clearly  indicates  the  use  to  be  made  of  the  word  "value"  in 
connection  with  the  appraisals  of  the  property  made  for  rate 
determinations : 

"A  thing  may  be  valuable  without  any  reference  to  money,  but 
whenever  we  speak  of  value  in  the  economic  sense,  we  express  it  in 
terms  of  money,  and  value  is  nothing  but  a  ratio,  an  expression  of  a 
relation  between  money  and  the  article  valued.  Now,  what  determines 
the  ratio;  what  determines  the  relation?  It  is  nothing  more  nor  less 
than  a  mental  condition.  It  is  a  state  of  mind  with  reference  to  the 
article,  and  not  an  attribute  or  quality  of  the  article  itself.  If  you 
happen  to  own  a  fine  residence,  upon  a  fine  street,  with  some  vacant 
lots  near  you  which  you  consider  to  be  worth  any  given  sum  of  money, 
we  will  say,  for  example,  $10,000,  and  suddenly  upon  one  side  of 
you  there   is  put  up  an  Italian  boarding  house,  and  upon  the  other 

■  National  Water-worka  Co.  vs.  Kansas  City,  02  Fed.  865. 


70  VALUE  FOR  RATE-MAKING 

side  a  drinking  saloon,  something  has  happened  to  the  value  of  your 
property.  What  is  it?  The  property  is  there  just  the  same;  there 
is  no  change  in  the  property  itself.  The  house  is  just  as  good,  the  lot 
is  just  as  good.  But  what  you  could  sell  for  $10,000  before  you  cannot 
now  sell  for  $5,000,  we  will  assume.  The  surrounding  circumstances 
are  such  as  to  change  the  estimation  of  people  who  would  want  to  buy 
such  a  piece  of  property  regarding  it.  Before  they  would  rather  have 
the  property  than  $10,000.  Now  they  would  rather  have  the  $10,000 
than  the  property,  and  will  part  with  only  $5,000,  showing  that  the 
value  is  nothing  but  a  relation  between  money  and  the  article  valued, 
and  that  relation  depends  upon  the  state  of  men's  minds.  That  may 
seem  rather  metaphysical,  and  rather  theoretical,  but  it  is  the  funda- 
mental principle  which  you  must  grasp  if  you  are  going  to  solve  this 
question  of  value."' 

Present  Value. — In  determining  the  value  of  utility  property, 
not  only  must  the  quality  of  fairness,  as  between  the  owners  and 
the  public,  be  considered,  but  the  fair  value  at  the  date  of  the 
inquiry,  that  is,  present  fair  value  must  be  established.  ''Pres- 
ent" value  means  the  "here  and  now"  value  of  the  property 
used,  useful,  or  reasonably  required  for  the  service  being  rendered. 
Fair  present  value  is  the  result  of  a  judgment  formed  from  the 
consideration  of  the  "facts,  figures  and  law"  involved  in  each 
particular  case. 

"What  the  company  is  entitled  to  demand,  in  order  that  it  may 
have  just  compensation,  is  a  fair  return  upon  the  reasonable  value  of 
the  property  at  the  time  it  is  being  used  for  the  public."^ 

"In  estimating  the  value  of  the  property,  we  must  take,  not  what  was 
its  value  in  the  past,  nor  what  it  cost,  nor  what  it  would  cost  to  duplicate 
it,  nor  its  probable  future  value,  but  the  estimate  must  be  based  on  its 
present  value. "^ 

"Under  the  authorities,  in  fixing  the  rate  to  be  charged  for  the 
'public  service'  by  private  corporations,  two  elements  of  calculation 
are  of  fundamental  importance:  What  is  the  true  present  value  of  the 
property  embarked  in  the  enterprise?  and  what,  in  view  of  the  risks  of 
business,  is  a  fair,  annual  percentage  of  return  thereon?"'* 

"It  is  impossible  to  observe  this  continued  use  of  the  present  tense 
in  these  decisions  of  the  highest  court,  without  feeling  that  the  actual 

'  Address  delivered  before  tlie  American  Elcctrio  Railway  Association  af  Atlantic  City, 
Oct.  14,  1914. 

*  San  Diego  Land  &  Town  Company  vs.  National  City,  174  V.  S.  57."). 
'  .Matthcw.s  vs.  Board  of  Corp.  Com'rs,  106  Fed.  7,  9. 

*  Consolidated  Gas  Co.  vs.  Mayer,  146  Fed.  1.50,  150. 


FAIR  VALVE  FOR  RATK-MAKIXC  71 

or  reproductive  value  at  the  time  of  the  inquiry  is  the  fust  and  most 
important  figure  to  be  ascertained."^ 

This  doctrine,  as  thus  announced,  was  sustained  in  tlic  famous 
New  York  City  gas  case  by  the  United  States  Supreme  Court  in 
the  following  plain  statement: 

"There  must  be  a  fair  return  upon  the  reasonable  value  of  the  property 
at  the  time  it  is  being  used  for  the  public."^ 

In  Cotting  vs.  Kansas  City  Stock  Yards  Co.  there  is  a  review 
of  all  the  prior  cases  decided  by  that  court  involving  the  fixing 
of  rates  by  legislative  enactment  and  reaffirmation  of  its  previous 
position. 

"It  (the  Supreme  Court)  has  declared  that  the  present  value  of  the 
property  is  the  basis  by  which  the  test  of  reasonableness  is  to  be  deter- 
mined, although  the  actual  cost  is  to  be  considered,  and  that  the  value 
of  the  services  rendered  to  each  individual  is  also  to  be  considered."* 

In  Cumberland  Tel.  &  Tel.  Co.  vs.  City  of  Louisville,  187 
Fed.  637,  on  page  642,  the  rule  is  stated  as  follows: 

"It  would  seem  clear  from  the  decisions  that  the  most  material 
question  in  such  cases  is  that  of  the  reasonable  value  of  the  property 
'at  the  time  it  is  being  used  for  the  public' — that  is  to  say,  the  time  at 
which  the  question  arises — it  being  upon  the  reasonable  valuation  at 
that  time  that  the  company  is  entitled  to  earn  a  fair  return.  *  *  * 
The  value  of  a  plant  may  depend  upon  good  fortune,  upon  good  manage- 
ment, or  upon  fortuitous  circumstances,  but  in  every  event  the  reason- 
able value  of  the  property  'at  the  time  it  is  used  for  the  public'  is  the 
value  we  are  to  ascertain  for  the  purposes  of  this  controversy." 

"The  property  is  held  in  private  ownership,  and  it  is  that  property, 
and  not  the  original  cost  of  it,  of  which  the  owners  may  not  be  deprived, 
without  due  process  of  law."^ 

In  Louisville  &  N.  R.  Co.  vs.  Railroad  Commission,  196  Fed. 
800,  an  objection  was  made,  because,  in  fixing  the  value  of  the 
plant,  present  prices  were  used  instead  of  those  prevailing  at  the 
time  the  plant  was  constructed.  In  answer  to  this  objection, 
the  Court,  at  page  821,  says: 

"One  of  the  objections  of  the  respondents  is  that  the  estimates  were 
based  on  the  prices  of  1907  when  they  were  made,  and  that  they  were 

»  Consolidated  Gas  Co.  vs.  Wilcox,  157  Fed.  849. 
^  Wilcox  vs.  Consolidated  Gas  Co..  212  U.  S.  19,  41. 
^  Cotting  vs.  Kansas  City  Stock  Yards,  etc.,  183  U.  S.  91. 
*  Simpson  vs.  Shepard,  230  U.  S.  352. 


72  VALUE  FOR  RATE-MAKING 

then  unusually  high.  This  is  disposed  of  by  the  point  that  present 
values  are  required  to  be  taken  and  used  in  determining  present  and 
prospective  rates." 

The  recent  case  of  Des  Moines  Water  Co.  vs.  City  of  Des 
Moines,  192  Fed.  193,  is  a  thoroughly  considered  case,  both  by 
the  master  and  by  the  Court  which  affirmed  the  master's  de- 
cision.    In  that  case,  at  page  196,  is  the  following  statement: 

"The  question  is  not  what  it  (the  plant)  cost,  although  such  evidence 
is  admissible  as  having  a  bearing.  The  question  is  not  what  the  plant 
some  day  may  be  worth,  although  evidence  with  reference  thereto  may 
be  considered  as  having  a  bearing.  The  question  is :  What  is  the  value 
of  the  plant  to-day?  There  must  be  a  reasonable  rate  of  interest  or 
dividends  allowed  on  the  value  of  the  plant." 

Eminent  authorities  in  the  line  of  engineering,  law  and  eco- 
nomics differ  in  the  valuation  of  utility  properties,  as  to  whether 
"present  cost,"  as  enunciated  by  the  Court,  shall  be  taken  to 
mean  the  cost  new  or  whether  that  cost  must  be  reduced  by  an 
estimated  amount  of  accruing  depreciation  not  yet  fully  accrued. 
The  lower  courts  and  commissions  have  given  conflicting  opinions 
on  this  point  and  the  superior  court  has  rendered  somewhat 
indefinite  and  contradictory  decisions  on  this  particular  ques- 
tion. It  is  difficult  to  understand  why  the  term  used  by  the 
Supreme  Court  "present  cost"  should  be  taken  by  anyone  to 
mean  present  cost  less  depreciation.  It  should  be  noted  that 
the  Supreme  Court  avoids  saying  that  accruing  depreciated  cost 
is  the  present  value,  such  meaning  simply  being  a  contortion 
of  the  statement  of  the  decision  in  the  Smyth  vs.  Ames  case. 

In  a  rate  case,  the  question  to  be  determined  is  the  present — 
meaning  now — value  of  the  property,  being  used  for  the  service 
of  the  public.  This  value  is  to  be  fixed  by  the  exercise  of  judg- 
ment, from  a  consideration  of  the  several  evidences  of  cost, 
namely,  the  original  investment,  the  reproduction  cost  new,  and 
both  of  these  reduced  by  the  cost  of  discarded  and  no  longer 
useful  apparatus  to  get  present  cost,  as  well  as  a  consideration  of 
the  market  value  of  stocks  and  bonds,  together  with  expenditures 
for  improvements  and  maintenance. 

Where  records  of  investment  are  not  available  reproduction 
cost  becomes  all-important  in  determining  the  value  of  the  property 
serving  the  public,  which  present  value  exists  regardless  of  the 
credit  of  the  corporation,  the  state  of  its  assets,  or  whether  the 


FAIR  VALUE  FOR  RATK-MAKIXG  7:i 

corporation  obtained  the  property  as  the  resuh  of  (he  side  of 
bonds,  stocks,  notes,  by  gift  or  from  accuniidations  of  suri)lus. 

Rates  cannot  be  based  upon  earnings  i)revious  to  (lie  inaug- 
uration of  public  regulation  of  such  earnings.  If  attempt  wen; 
made  to  consider  past  earnings  in  determining  value  of  property, 
should  the  consideration  include  earnings  for  one,  two,  five  or  ten 
years,  and  if  so,  why  not  for  a  longer  period,  say  from  the  origin 
of  the  company.  If  the  earnings  should  be  found  to  be  nion; 
than  a  fair  return  upon  the  value  of  the  property,  in  addition  to 
a  proper  sum  to  cover  all  depreciation,  why  should  not  such  ex- 
cess be  also  deducted  from  cost  new,  in  determining  present  value, 
the  same  as  it  is  proposed  to  deduct  the  amount  of  a  theoretically 
computed  reserve  fund.  Such  procedure,  while  logical,  would 
not  be  reasonable  or  justified  by  the  courts,  for  no  corporation 
can  retroactively  be  required  to  account  for  its  surplus  or  its 
deficiency  previous  to  the  initiation  of  public  regulation. 

"Should  the  Government  to-day  take  note  of  that  surplus  for  the 
purpose  either  of  so  reducing  the  rates  of  the  company  that  no  earnings 
can  be  made  upon  this  much  of  the  property,  or  with  a  view  in  some 
sense  to  turn  that  surplus  back  again  into  the  hand  of  the  public? 

"During  all  this  period  the  excess  has  gone  into  the  property,  which  has 
gradually  become  more  valuable,  and  this  increased  value  has  reflected 
itself  in  the  market  price  of  the  securities  of  that  company.  It  is 
impossible  to  restore  what  has  been  improperly  taken  in  the  way  of 
excessive  rates  to  those  persons  from  whom  it  has  been  received.  The 
Government,  under  those  circumstances,  cannot  lay  hold  on  this  surplus 
as  a  fund  held  in  trust  for  the  public. 

"This  case  strongly  illustrates  the  fact  that  if  any  Government  tribunal 
is  to  do  justice  between  the  railway  and  the  public,  if  it  is  to  feel  any 
confidence  in  the  correctness  of  its  conclusions,  its  supervisions  must 
be  continuous  and  not  spasmodic.  There  must  be  some  point  of  de- 
parture and  from  that  point  the  knowledge  of  the  Government  must  be 
accurate  and  complete.  After  earnings  have  once  been  'capitalized' 
and  benefits  have  been  'conferred,'  when  the  various  independent 
organizations  have  been  perfected ^  it  is  impossible  to  either  know  or  to 
undo."i 

The  Supreme  Court,  of  the  State  of  Massachusetts,  has 
definitely  held— contrary  to  the  order  of  the  Gas  and  Electric 
Light  Commissioners — that  a  utility  is  entitled  to  capitalize 
proper  expenditures  for  plant  additions,  regardless  of  and  aside 

'  Commissioner  Prouty  of  the  Interstate  Commerce  Commission  in  Spokane  vs.  Northern 
Pacific  Railway  Company,  15  I.  C.  C.  R.  376,  4ir>,  Feb.  <),  1909. 


74  VALUE  FOR  RATE-MAKING 

from  what  profits  it  may  have  earned.  The  Fall  River  Gas 
Works  Company,  after  pa3'ing  dividends  at  the  rate  of  10  or 
12  per  cent,  per  annum,  had  remaining  as  profits  an  amount 
exceeding  bona  fide  obligations  incurred  in  making  additions  to 
plant  and  property  of  S200,000,  for  which  notes  had  been  issued, 
plus  $40,000  for  proposed  equipment  expenditures.  The  cor- 
poration, instead  of  applying  its  profits  to  the  discharge  of  these 
obligations,  distributed  its  profits  among  its  stockholders  in  the 
form  of  two  extra  dividends  of  15  and  20  per  cent,  respectively. 
Afterward  the  company  sought  the  Commission's  approval  of 
the  issuance  of  1,150  shares  of  additional  capital  stock  at  the 
price  of  S225  per  share,  the  proceeds  to  be  used  to  meet  the 
$240,000  of  notes  and  proposed  expenditures.  The  Commis- 
sioners refused  to  authorize  the  issuance  of  stock  on  the  grounds 
that  the  profits  of  the  company  were  sufficient  to  take  up  the 
notes  without  increasing  the  capital  account;  the  Commission 
did  not  question  the  propriety  or  reasonable  necessity  of  the 
plant  additions,  or  that  the  amount  expended  represented  their 
cost  and  real  value.  The  Court,  in  overruling  the  Commission's 
refusal  to  authorize  the  issuance  of  additional  capital,  says: 

"When  the  corporation  has  performed  all  its  duties,  and  by  its  for- 
tunate situation,  good  management,  or  any  lawful  conduct  has  remain- 
ing a  surplus  of  earnings,  it  has  the  right  to  distribute  this  surplus  among 
its  stockholders  in  dividends.  As  between  the  public  and  the  corpora- 
tion the  earnings  belong  to  the  corporation.  In  performing  its  full 
duty  to  the  public  and  others  it  has  done  what  it  was  chartered  to  do, 
and  is  entitled  to  the  profits  of  the  business  for  which  it  was  chartered. 
If  there  be  any  reserved  power  in  the  charter  whereby  the  profits  can 
be  reduced  or  the  charter  revoked,  of  course,  that  power  may  be  invoked 
if  it  appear  that  the  charter  is  too  favorable  to  the  corporation.  And 
in  the  case  of  a  gas  company  the  profits  may  be  reduced  by  an  order 
lowering  the  price  of  gas,  if  such  order  seems  just  and  reasonable. 
(R.L.,  c.  121,  §34.)  The  relations  between  a  public-service  cor- 
poration and  the  public  to  serve  whom  it  is  chartered  are  not  that  of  a 
partnership,  but  rather  that  of  independent  contracting  parties.  The 
public  may  demand  proper  service,  and  with  that  demand  the  corpora- 
tion must  comply.  The  company  may  demand  fair  compensation  for 
this  service,  and  with  that  demand  the  public  should  comply.  The 
corporation  can  have  no  share  in  the  benefit  to  the  public,  nor  can  the 
public  have  any  share  in  the  net  profits  available  for  dividends. 

"Upon  the  question  whether  there  shall  be  an  issue  of  additional 
stock  to  meet  liabilities  incurred  in  increasing  the  efficiency  or  value  of 


FAIR  VALUE  FOR  RATE-MAKING  75 

the  plant,  the  amount  of  undivided  profits  on  hand  at  the  time  (ho 
liabiUties  were  incurred  or  the  expenditures  made  which  thercaffcr- 
ward  and  before  the  apphcation  to  the  Board  have  been  hiwfully 
distributed  as  dividends  is  (Mitirely  ininuiterial.  We  see  nothing  to  take 
this  case  out  of  the  general  rule. 

"Nor  is  this  proposed  increase  a  violation  of  the  statutory  provision 
against  the  issue  of  a  stock  dividend.  It  certainly  is  not  in  form  such 
an  issue.  Nor  is  it  in  substance.  The  sum  raised  goes  to  increase 
the  value  of  the  plant  for  the  purposes  of  the  business  for  wliich  the 
petitioner  was  incorporated;  S,nd  that  is  none  the  less  true,  even  if  these 
expenses  could  have  been  paid  by  the  funds  since  lawfully  distributed 
as  dividends. 

"It  follows  that  in  the  decision  to  dismiss  the  petition  upon  the  grounds 
stated  in  the  record  there  was  error  in  law.""^ 

Property  kept  in  first-class  operating  condition  is  entitled  to 
a  fair  return  on  the  full  value  of  that  property,  without  deduction 
for  theoretical,  accruing  depreciation,  which  does  not  yet  call 
for  any  renewal  of  parts.  The  fact  that  the  property  is  rendering 
100  per  cent,  service  must  be  determined  by  inspection  and  not 
from  a  consideration  of  life  tables. 

The  consumer  is  only  interested  in  the  service  rendered  and 
is  not  concerned  as  to  just  when  certain  parts  of  the  plant  must 
be  replaced  from  one  cause  or  another.  The  present  value  of 
the  plant,  as  far  as  the  consumer  goes,  is  its  present  value  to 
render  the  requisite  service,  without  regard  to  the  amount  of 
cash  or  reserve  funds  on  hand  or  the  expectation  of  life  of  the 
several  parts  of  the  physical  property,  as  computed  by  various 
methods  and  differing  experts. 

It  is  not  claimed  that  the  cost  new  of  all  the  property  that  may 
be  owned  and  inventoried  is  the  proper  value  to  be  taken  as  the 
basis  for  determining  rates.  This  is  illustrated,  for  example, 
by  the  fact  that  claim  is  made  only  for  scrap  or  salvage  value  of 
apparatus,  held  simply  awaiting  a  favorable  opportunity  of  sale, 
no  longer  used  in  service  to  the  public,  having  been  displaced  by 
new  apparatus.  It  is  admitted  if  the  value  of  superseded, 
obsolete,  inadequate  or  not  actually  used  property  is  included  in 
the  inventory  at  cost  new  that  such  value  must  be  reduced  by 
the  full  amount  of  depreciation  necessary  to  represent  such  actual 
deterioration.  Depreciation  of  the  class  here  referred  to  can  be 
properly  determined  only  by  inspection  of  the  physical  property, 

>  Fall  River  Gas  Works  Co.  vs.  Board  of  Gas  and  Electric  Light  Commissioners,  214 
Mass.  529. 


76  VALUE  FOR  RATE-MAKING 

and  in  most  utilities  a  deduction  on  account  of  such  depreciation 
will  amount  to  but  a  few  per  cent,  of  the  cost  new.  With  de- 
duction having  been  made  for  such  deterioration  as  is  shown  to 
exist  as  the  result  of  inspection,  the  full  remainder  of  the  cost 
new  represents  present  value.  In  this  manner  only  is  the  cost 
new  of  all  property  inventoried  and  fairly  appraised,  to  be  re- 
duced for  the  purpose  of  fixing  fair  returns  and  determining 
rates. 

Court  Decisions. — It  is  conceded  that  the  decisions  of  some 
authorities  hold  that,  in  determining  the  value  of  property 
upon  which  to  fix  rates  of  returns,  deduction  from  cost  new,  on 
the  basis  of  a  theoretical  computation  should  be  taken  into 
account,  but  this  is  not  the  ruling  of  the  United  States  Supreme 
Court. 

In  considering  any  decision  of  the  Supreme  Court,  it  must 
be  borne  in  mind  that  the  Court  is  passing  on  the  particular 
case  in  question  and  any  conclusions  reached  are  based  upon 
the  peculiar  circumstances  surrounding  that  particular  property. 
Consequently,  too  much  importance  should  not  be  attached  to 
the  decision  of  the  Supreme  Court  in  some  individual  case  when 
attempting  to  arrive  at  the  fundamental  principles  which  may 
be  applied  generally.  While  it  is  true  that  the  last  word  in 
any  particular  instance  rests  with  the  Supreme  Court,  and 
that  such  Court  is  given  to  following  precedent,  nevertheless, 
it  cannot  be  presumed  that  the  Court  will  seek  to  perpetuate 
what  may  be  demonstrated  to  be  a  wrong,  merely  to  avoid 
reversing  itself. 

No  question  can  be  regarded  as  finally  settled  until  settled 
equitably.  Because,  in  the  Consolidated  Gas  case,  the  Supreme 
Court  held  that  to  maintain  a  pressure  of  2}-^  in.  (0.09  11).  per 
square  inch)  in  all  gas  pipes  in  the  distributing  system  in  New 
York  City,  "the  mains  and  other  pipes  would  have  to  be  strength- 
ened" is  so  contrary  to  fact  and  what  even  the  commonest 
laborer  employed  about  gas  works  knows  to  be  the  fact,  that 
eventually  the  Supreme  Court  nuist  reverse  itself  on  this  con- 
clusion, rather  than  that  the  laws  of  nature  are  to  be  revised. 

Minnesota  Rate  Cases. — In  the  same  way,  the  statement  of 
Judge   Hughes  in   the  Minnesota  rate  cases  to  the  effect  that 

"We  also  think  it  was  an  error  to  add  to  the  amount  taken  as  the 
present  value  of  the  lands,  the  further  sums  calculated  on  that  value. 


FA  IJi   VALUE  FOR  RA  TE-M  A  K I XC  77 

which   are   embraced   in   the   items   of   'engineerinfr/'superinteiulence,' 
'legal  expenses,'  'contingencies'  and  'interest  during  constructi<jn,' " 

and  the  further  statement  in  the  same  decision, 

"It  is  impossible  to  assume,  in  making  a  judicial  finding  of  wliat  it 
would  cost  to  acquire  the  property  that  the  company  would  be  com- 
pelled to  pay  more  than  its  fair  market  value.  It  is  equipped  with  the 
governmental  power  of  eminent  domain," 

are  contrary  to  common  knowledge  and  experience.  Any  ap- 
parent conclusion  that  a  railroad  could  purchase  real  estate  by 
reason  of  its  right  of  eminent  domain  at  the  value  of  adjoining 
land  is  so  contrary  to  common  knowledge  and  experience  in 
railway  construction  that  the  estabhshment  of  such  principles 
could  not  be  accepted  even  if  attempted  by  the  Supreme  Court. 
If,  in  the  Minnesota  rate  cases,  evidence  was  improperly  pre- 
sented as  to  the  necessity  for  allowing  engineering  and  other 
incidental  expenses,  or  the  fact  that  real  estate  cannot  be  pur- 
chased at  the  value  of  adjoining  land,  was  not  established  in  the 
record,  that  may  have  been  sufficient  grounds  for  the  refusal 
of  the  Supreme  Court  to  accept  the  values  claimed  by  the  rail- 
roads, but  any  deficiency  in  the  evidence  necessary  to  prove 
the  proper  basis  of  value  upon  which  to  fix  rates  cannot  be  as- 
sumed as  conclusive  and  a  safe  premise  on  which  to  base  a 
succeeding  case  in  which  it  may  be  presumed  the  Court  will  have 
full  and  proper  information  on  these  subjects. 

It  is  more  than  likely  that  what  the  Court  in  the  Minnesota 
rate  cases  was  pointing  out  as  error  in  the  values  claimed  for 
rights-of-way  was  that  the  valuation  had  been  made  upon  the 
wrong  theory,  which  was  an  estimate  in  excess  of  the  market  value 
of  contiguous  and  similar  property  increased  by  the  multiplier, 
three.  That  upon  such  erroneous  basis  or  amount,  further  sums 
could  not  be  fairly  added  for  "engineering,  superintendence, 
legal  expenses,  contingencies  and  interest  during  construction." 
There  is  no  warrant  for  supposing  that  the  Court  would  have 
condemned  a  method  which  started  with  the  fair  market  value 
of  contiguous  property  and  increased  that  amount  by  the  projM-r 
multiplier.  It  would  be  absurd  to  assume  that  the  Court  m- 
tended  to  imply  that  the  railroad,  at  present,  was  only  entitled 
to  such  value  for  its  right-of-way  as  that  right-of-way  had  cost 
when  the  railroad  was  built  perhaps  half  a  century  ago,  or  what 
it  would  cost  if  the  territory  had  never  been  served  by  a  railroad. 


78  VALUE  FOR  RATE-MAKING 

Consolidated  Gas  Case. — The  particular  question  with  ref- 
erence to  whether  the  amount  of  depreciation  of  physical  prop- 
erty was  to  be  determined  from  actual  inspection  or  from  cal- 
culations based  on  estimated  life  tables  was  squarely  involved 
in  the  Consolidated  Gas  case  and  definitely  passed  upon  by  the 
master  appointed  to  take  the  testimony  in  that  celebrated  case. 
The  total  valuation  of  that  property  was  some  $56,000,000,  It 
was  shown  that  an  expenditure  of  $604,988  for  "repairs"  (slightly 
over  1  per  cent.)  would  make  the  plant  as  good  as  new,  and  this 
is  the  only  sum  that  was  deducted  from  the  reproduction  cost 
new,  notwithstanding,  it  was  most  vigorously  contended  by  the 
plaintiff  in  that  case  that  a  further  deduction  of  millions  of 
dollars  should  be  made  for  theoretical  or  "accrued"  deprecia- 
tion. The  master  says,  regarding  the  testimony  of  the  expert 
for  the  plaintiff,  Mr,  Marks,  and  for  the  defendant,  Mr.  Mayer, 
that 

"Mr.  Marks  did  not  particularly  regard  the  extent  of  depreciation 
actually  existing,  but  assumed  a  theoretical  deterioration  of  the  supposed 
life  of  the  plant.     He  testified: 

'Depreciation  results  from  several  causes.  The  most  ordinary  one 
is  decay  or  wear  and  tear,  as  observed.  There  is  another  factor  which 
is  inadequacy,  owing  to  the  increase  of  the  business.  There  is  also 
another  cause  of  depreciation,  obsolescence,  which  is  due  to  the  changes 
in  the  arts  and  in  the  methods  and  in  the  general  growth  of  scientific 
knowledge;  if  a  works  built  at  a  certain  period  is  kept  in  perfect  repair, 
meaning  by  that,  always  restored  to  their  original  condition,  there 
remains,  assuming  that,  a  depreciation  due  to  both  obsolescence  and  to 
inadequacy.' 

"In  this  view  he  made  estimates  on  the  theory  of  the  cost  of  final 
replacement  to  cover  such  inadequacy  or  obsolescence,  ranging  from 
25  per  cent,  to  60  per  cent,  and  based  on  a  supposed  life  of  120  years 
for  the  plant.  The  discrepancy  between  his  valuations  and  those  of 
Mr.  Mayer  is  largely  due  to  their  different  methods  of  estimating  de- 
preciation.    He  said: 

'Mr.  Mayer  does  not  differ  largely  from  my  own  figures  of  structural 
cost.  You  may  say  for  all  ordinary  purposes  they  coincide,  with  the 
exception  of  the  gas  holders  and  even  there  they  do  not  differ  largely. 
It  is  the  question  of  depreciation  entirely.' 

"As  will  hereafter  appear,  it  is  proper  in  the  administration  of  a 
manufacturing  plant  to  take  depreciation  of  the  character  above 
described  into  account  and  provide  against  it  by  setting  aside  a  reserve 
fund  from  current  earnings.     For  the  purpose  of  determining  present 


FAIli   VALUE  FOJi  RATE-MAKING  TO 

value,  however,  particularly  on  the  basis  of  cost  of  reproduction,  the 
method  followed  by  Mr.  Marks  does  not  commend  itself.  It  app(!ars 
from  the  record,  without  substantial  dispute,  that  while  certain  (»f  the 
plants  and  apparatus  may  not  be  in  perfect  repair,  they  are  as  a  whole 
in  efficient  operating  condition,  and  that  a  large  proportion  of  their 
capacity  is  represented  by  the  latest  pattern  of  water  gas  apparatus 
installed  within  the  last  few  years.       *  *  * 

"The  fact  thus  being  that  the  plants  are  in  good  order  and  operating 
efficiently,  it  does  not  appear  reasonable,  for  the  purposes  of  this  case, 
to  charge  them  with  a  theoretical  deficiency  so  great,  as,  if  actually 
existing,  would  make  their  successful  operation  a  practical  impossi- 
bihty.  An  estimate  of  depreciation  like  those  of  Mr.  Edgerton  and 
Mr.  Mayer,  based  on  a  detailed  examination  of  the  property  as  it  stands 
to-day,  affords  in  my  opinion  a  more  fair  and  j^racticable  method  to  be 
followed  in  determining  its  value." ^ 

The  master,  in  this  case,  in  dealing  with  the  allog(>(l  necessity 
for  a  reserve  fund  to  provide  for  "final  renewals"  when  the  life 
of  the  apparatus  should  expire,  says: 

"Of  course,  the  requirement  of  such  'final  renewal'  provision  affects 
in  no  way  the  present  value  or  efficiency  of  the  plants  of  the  company  as 
operating  concerns,  except  to  the  extent  of  the  repairs  ($604,988  above 
mentioned),  which  would  be  required  to  make  the  operating  plant  as 
good  as  new."^ 

From  the  above,  which  is  probably  as  full  an  exposition  of 
the  proper  basis  for  estimating  depreciation  as  was  ever  passed 
by  the  Supreme  Court,  several  important  points  would  seem 
to  be  made  clear: 

(a)  Depreciation  should  be  determined  by  personal  inspection 
rather  than  by  theoretical  estimate. 

(b)  Property  that  is  in  good  order  and  operating  efficiently, 
although  not  new,  need  not  necessarily  be  depreciated,  at  least 
in  rate  cases. 

The  decision  of  the  Supreme  Court  in  the  ConsoUdated  Gas 
case  has  not  been  given  due  consideration  in  the  matter  of 
depreciation  as  against  the  same  court's  decision  in  the  Knoxville 
Water  case,  although  both  decisions  were  rendered  the  same 
day.  In  the  writer's  opinion  there  is  no  contradiction  betwoon 
these  decisions  as  to  the  meaning  of  "fair  value"  or  method  of 
allowing  for  depreciation  if  the  decisions  are  fairly  interpreted. 

'  Mastor's  Report,  Consolidated  Gas  Co.  of  New  York.      Filed  June  24.   1907,  pane   i:(7. 


80  VALUE  FOR  RATE-MAKING 

Fair  Rate. — The  fair  return  that  should  be  allowed  will  vary 
under  different  circumstances  and  localities  and  must  be  de- 
termined for  the  particular  case  being  considered.  The  fixing 
of  a  fair  return  is  an  entirely  separate  and  distinct  question  from 
determining  the  fair  value  of  the  property  used.  In  fairness, 
one  cannot  be  made  low  and  offset  by  making  the  other  high, 
and  vice  versa.  Consequently,  no  attempt  is  made  herein  to 
name  all  the  elements  to  be  considered,  but  rather  merely  to 
discuss  what  may  be  some  of  the  general  principles  for  arriving 
at  and  fixing  a  fair  rate  of  return,  bearing  in  mind  the  fact  that 
the  rate  of  return  is  entirely  independent  of  and  distinct  from 
the  fair  value  of  the  property. 

The  now  generally  accepted  view  prevails  that  the  utility  is 
not  only  entitled  to  have  the  fair  present  value  of  its  property 
recognized,  but  the  return  allowed  upon  the  value  must  also  be 
sufficient  to  sustain  and  maintain  that  value. 

"But  as  it  is  firmly  established  that  it  is  within  the  scope  of  judicial 
power,  and  a  part  of  judicial  duty,  to  inquire  whether  rates  so  established 
(by  Municipal  Ordinance)  operate  to  deprive  the  owner  of  his  property 
without  just  compensation,  it  seems  to  me  that  it  logically  follows  that 
if  the  Court  finds  from  the  evidence  produced  that  they  are  manifestly 
unreasonable,  it  is  its  duty  to  adjudge  and  to  annul  them,  for  it  is  plain 
that  if  they  are  manifestly  unreasonable,  they  cannot  be  just.  In  the 
solution  of  that  problem  many  considerations  center;  among  them, 
the  amount  of  money  actually  invested.  But  that  is  by  no  means,  of 
itself,  controlling,  even  where  the  property  was  at  the  time  fairly  worth 
what  it  cost.  If  it  has  since  acquired  any  value,  those  who  invest 
their  money  in  it,  like  others  who  invest  their  money  in  any  other  kind 
of  property,  are  fully  entitled  to  the  benefit  of  the  increased  value.  If, 
on  the  other  hand,  the  property  has  decreased  in  value,  it  is  but  right 
that  those  who  invested  their  money  in  it,  and  took  the  chance  of  the 
increase  of  value,  should  bear  the  burden  of  the  decrease.  In  my  judg- 
ment, it  is  the  actual  value  of  the  property  at  the  time  the  rates  are 
fixed  that  should  form  the  basis  upon  which  to  compute  just  rates, 
having  at  the  same  time  due  regard  to  the  rights  of  the  public,  and  to 
the  cost  and  maintenance  of  the  plant  and  its  depreciation  by  reason 
of  wear  and  tear."^ 

The  more  usual  view  of  the  courts  as  to  the  controlling  principle 
to  guide  in  fixing  rates  has  been  clearly  set  out  in  the  Spring 
Valley  Water  Works  decision  as  follows: 

1  San  Diego  Land  &  Town  Co.  vs.  City  of  National  City,  74  Fed.  Rep.  S3. 


FAIR  VALUE  FOR  RATE-MAKING  81 

"It  is  not  a  matter  of  guess  work  or  any  arbitrary  fixing  of  rates  with- 
out reference  to  the  rights  of  the  water  company  or  the  public.  When 
the  constitution  provides  for  the  fixing  of  rates  or  compensation,  it 
means  reasonable  rates  and  just  compensation." ^ 

The  above  view  has  not  been  uniformly  held.  Although 
Judge  Brewer,  in  a  railroad  case,  makes  the  following  startling 
statement,  his  conclusion  is  not  in  accord  with  the  later  lulings 
of  the  courts  as  was  shown  under  "Development  of  Law,"  pag(!  7: 

"Whether  by  reducing  the  compensation  to  a  minimum  railroad 
enterprises  shall  be  discouraged,  or,  enlarging,  encouraged,  is  a  matter 
for  legislation,  and  not  judicial  determination.  Take  a  kindred  matter. 
It  is  within  the  power  of  the  Legislature  to  prescribe  the  rate  of  interest, 
and  to  punish  by  severe  penalties  the  exaction  of  larger  than  the  legal 
rate.  What  that  legal  rate  shall  be  is  not  for  the  courts,  but  for  the 
Legislature,  to  determine.  Suppose  the  Legislature  of  Iowa  should 
reduce  the  legal  rate  of  interest  to  1  per  cent.,  although  such  Legislature 
would  prevent  capital  from  coming  into  the  State,  would  the  courts 
have  power  to  declare  the  law  unconstitutional?  In  like  manner,  the 
rulings  of  the  Supreme  Court  imply  that  the  Legislature  may  reduce 
railroad  rates  until  only  a  minimum  of  compensation  is  secured  to  the 
owner.  The  rule,  therefore,  to  be  laid  down  is  this:  that  where  the 
proposed  rates  will  give  some  compensation,  however  small,  to  the 
owners  of  the  railroad  property,  the  courts  have  no  power  to  interfere."^ 

A  fair  return  upon  utility  property  may  equitably  be  taken 
to  mean  an  amount  sufficient  to  cover  ordinary  interest  and,  in 
addition,  some  reward  or  profit  based  on  the  local  conditions  and 
risks  incidental  to  the  requirements  of  invested  capital,  under 
the  particular  circumstances  in  question.  This  fair  return  is 
over  and  above  all  expenditures  for  service,  the  expenses  of  con- 
ducting the  business  and  the  costs  of  maintaining  the  property 
in  first-class  operating  condition.  Of  course,  operating  expenses 
include  expenditures  for  fuel,  oil,  water,  wages,  salaries,  taxes, 
normal  wear  and  tear,  and  maintenance,  as  \\iA\  as  renewals 
and  replacements,  whether  necessitated  by  exhaustion  of  j)hysical 
elements,  inadequacy,  obsolescence,  or  other  functional  depre- 
ciation. In  addition,  in  the  case  of  a  limited  franchise,  or  otiier 
similar  limiting  circumstance,  the  annual  operating  expenses 
must  include  an  amount  sufficient  to  provide  an  amortization 

'  Spring  Valley  Water  Works  vs.  the  City  &  County  of  San  Francisco,  82  Cal.  300. 
2  Chicago,  etc.,  R.  R.  Co.  vs.  Dey,  35  Fed.  Rep.  866. 
6 


82  VALUE  FOR  RATE-MAKING 

fund  that  will  return  to  the  owner  the  full  value  of  his  property 
at  the  expiration  of  its  term  of  service. 

In  considering  the  fair  return  to  be  allowed  investors  of  public 
utilities,  the  best  present-day  practice  bases  such  return  upon 
the  fair  present  value  of  the  property.  This  fair  present  value 
has  too  commonly  in  the  past  been  taken  to  include  but  little 
more  than  the  physical,  structural  property.  Recent  decisions 
of  regulating  bodies  and  the  reviews  of  these  matters  by  the 
courts,  recognize  that  a  return  must  be  allowed  not  only  on  the 
value  of  the  physical  plant,  but  also  upon  that  expenditure  which 
may  fairly  be  considered  necessary  for  developing  the  revenue 
and  attaching  the  business  to  the  plant. 

Surprising  as  it  may  seem,  the  authorities  have  held  in  a 
number  of  cases  that  the  value  of  the  property  and  the  rate  of 
return  are  interdependent,  but  any  such  views  are  erroneous. 
Mr.  R.  H.  Whitten,  largely  voicing  the  views  of  the  Public 
Service  Commission,  First  District,  State  of  New  York,  says: 

"Value  in  a  rate  case  is  the  amount  on  which  the  fair  return  should 
be  allowed,  in  order  to  adequately  compensate  the  investor.  The 
essential  thing  is  not  the  value  alone  or  the  rate  of  return  alone,  but 
the  net  income,  which  is  the  product  of  the  two.  So  long  as  the  net 
income  remains  unchanged  it  is  immaterial,  so  far  as  the  justice  of  the 
result  is  concerned,  whether  cost  of  creating  a  paying  business  is  taken 
care  of  by  increasing  fair  value  and  reducing  fair  rate  of  return  or  by 
increasing  fair  rate  of  return  and  reducing  fair  value.  A  reasonable 
net  income  is  the  fundamental  requirement."^ 

Mr.  Whitten  speaks  from  the  viewpoint  of  the  public  without 
due  consideration  of  the  effect  of  such  basis  of  fixing  rates  from 
the  investor's  standpoint.  Mr.  Whitten's  statement  is  true  in 
the  long  run  only  as  regards  the  consumer.  A  sudden  change 
in  the  prevailing  rates  for  money,  as  has  been  witnessed  re- 
cently by  the  outbreaking  of  the  European  war,  entitles  a  utility 
immediately,  without  time  for  a  revaluation,  to  a  larger  rate  of  re- 
turn on  the  value  of  its  property,  which  therefore  must  be  at 
all  times  the  fair  and  proper  value.  The  universal  tendency  is 
to  gradually  reduce  the  rate  of  return  as  public  utility  properties 
develop,  become  more  stable  and  the  cities  in  which  they  are 
located  increase  in  population  and  importance.  If  then,  the 
value  of  the  property  has  been  fixed  unfairly  low,  with  the  thought 

•  Valuation  of  Public  Service  Corporations,  page  507. 


FAIR   VALUE  FOR  RATE-M AKI M;  83 

that  the  net  income  allowed  is  the  same,  because  of  a  somewhat 
higher  rate  of  return,  the  reduction  in  the  rate  of  return  to  wlial, 
in  the  future,  may  be  considered  fair  by  some  other  reKulatiiijr 
body,  or  enforced  as  a  minimum  by  a  court  in  order  to  prevent 
confiscation,  will  yield  an  unfairly  low  income  as  compared  with 
what  that  income  would  have  been  had  the  full,  fair  value  of  t  he- 
property  always  been  recognized  and  allowed. 

Along  the  same  line  of  erroneous  reasoning,  the  Public  iServicc 
Commission,  First  District,  State  of  New  York,  in  substantiat- 
ing the  value  allowed  in  the  Queens  Borough  case  says: 

"The  data  used  to  determine  existing  depreciation  (and  therefrom 
the  present  value  of  the  property)  have  been  used  to  fix  the  amount  that 
should  annually  be  set  aside,  out  of  earnings,  to  meet  accruing  deprecia- 
tion. If  the  above  estimate  is  too  low,  then  the  annual  payment  is  too 
low.  But  if  the  above  estimate  is  too  low,  then  the  present  value 
is  too  high  and  the  amount  to  be  accepted  as  a  fair  return  on  'fair 
value'  should  be  reduced."^ 

Failure  to  appreciate  the  absolute  separation  of  rate  of  return 
from  fair  value  fails  to  afford  equity  to  the  investor.  The  proper 
rate  of  return  for  a  given  case  should  be  determined  not  only 
from  the  consideration  of  the  local  rate  for  money  and  risk  of 
the  particular  enterprise  under  consideration,  but  there  should 
also  be  included  an  allowance  that  will  encourage  efficiency 
and  enterprise. 

The  remarks  of  Edward  M.  Bassett,  then  a  member  of  the 
New  York  Public  Service  Commission,  First  District,  in  an 
address  delivered  by  him  on  Dec.  10,  1910,  before  the  Brooklyn 
Company  Section  of  the  National  Electric  Light  Association,  at 
its  regular  monthly  meeting,  are  very  much  in  point : 

"Efficiency  in  a  public-utiHty  corporation  redounds  not  only  to 
the  benefit  of  the  public,  but  should  redound  to  the  benefit  of  the  cor- 
poration itself.  The  saving  that  comes  from  thrift,  the  greater  earning 
capacity  that  comes  from  ingenuity  and  faithfulness,  is  properly  divided 
between  the  public  and  the  corporation  itself,  not  forgetting  the  payment 
of  good  wages  and  the  making  of  permanent  and  promising  positions 
for  those  that  contribute  to  that  result.  I  for  one  am  of  the  opinion 
that  public  regulation  should  incite  and  increase  and  encourage  private 
initiative,  thrift,  economy,  better  results  for  a  certain  amount  of  work, 
more  electricity  for  a  certain  number  of  pounds  of  coal,   and  that 

I  In  the  matter  of  the  Gas  &  Electric  rates  charged  by  the  Queens  Borough  Gas  &  Electric 
Company,  Vol.  II,  P.  S.  Comm.  Reports,  1st  Dist.,  Sept.  1909-Dcc.  1911.  page  ■>li2. 


84  VALUE  FOR  HATE-MAKING 

that  efficiency  should  not  entirely  or  anywhere  near  entirely  be  taken 
advantage  of  by  the  public,  but  the  corporation  that  can  produce  results 
is  entitled  to  a  large  measure  of  the  benefits  of  its  own  efficiency  and 
progress. 

"Public  regulation  will  in  no  sense  be  a  success  until  that  principle 
is  largely  recognized,  because  you  cannot  make  all  companies  the  same. 
If  you  try  to  make  all  the  same  it  will  be  pressing  down  the  capacity 
to  the  level  of  the  poorest  rather  than  raising  up,  or  the  endeavor  to 
raise  the  capacity  of  all  to  that  of  the  highest,  and  profit  for  the  investor, 
payment  of  good  wages,  and  the  ability  to  pay  good  wages  to  the  work- 
man, must  be  encouraged  by  the  State,  representing  all  the  people." 

That  the  highest  authorities  recognize  the  necessity  for 
varying  the  rate  of  return — independently  of  the  value  of  the 
property— is  shown  by  the  decision  of  the  United  States  Circuit 
Court  in  the  Minnesota  Rate  Cases  in  these  words: 

"The  legal  rate  of  interest  on  a  debt  in  Minnesota,  in  the  absence  of 
contract,  is  6  per  cent.,  and  by  contract  it  may  be  10  per  cent,  per  annum. 
Rev.  Laws  Minn.,  1905,  Sec.  2733.  Rational  investments  in  agriculture, 
manufacturing,  mercantile,  and  other  industrial  pursuits,  and  even 
well-secured  loans,  yield  returns  in  Minnesota  corresponding  with  these 
lawful  rates. 

"It  is  an  axiom  in  economics  that  the  greater  the  risk  the  greater 
must  the  returns  be  upon  invested  capital,  and  the  conclusion  is  ir- 
resistible that  a  net  return  of  7  per  cent,  per  annum  upon  the  respective 
values  of  the  properties  of  these  companies  in  Minnesota  devoted  to 
transportation  is  not  more  than  the  fair  return  to  which  they  are  en- 
titled under  the  Constitution  of  the  United  States. ""^ 

One  of  the  latest  and  clearest  opinions  of  any  State  court, 
bearing  on  this  subject,  is  that  rendered  in  the  Passaic  case, 
where  a  decision  by  the  Public  Utility  Commission  of  New 
Jersey  was  appealed  by  the  corporation  to  the  Supreme  Court. 

"To  induce  investment  and  continuance  of  capital  there  must  be 
some  hope  of  gain  commensurate  with  that  realizable  in  other  business. 
The  mere  assurance  that  the  investment  will  not  be  confiscated  would 
not  suffice."^ 

EflSicieiicy  in  Operation  and  Utilization. — The  value  of  service 
rendered  to  the  public  by  a  given  physical  plant  is  determined 
not  alone  by  the  actual  cost  of  that  plant,  but  as  much  or  more 
by  two  other  factors.     These  are: 

'  Shepard  vb.  Northern  Pacific  Railway  Co.  et  al,  184  Fed.  816. 

'  Public  Service  Gas  Co.  vs.  Board  of  Public  I'tility  Comniission  et  al,  87  Atlantic  655. 


FAIR  VALUE  FOR  RATE-MAKINCi  85 

(rt)   Efficiency  in  operation. 

{h)  The  degree  of  effective  utilization. 

The  many  questions  involved  in  ascertaining  the  fair  value  of 
the  property  has  resulted  in  many  instances  in  failure  to  properly 
analyze  and  determine  whether  or  not  the  operating  expenses 
are  such  as  may  properly  be  allowed,  or  whether  they  indicate 
efficiency  and  a  high  degree  of  business  acumen.  It  is  rather 
common  practice  to  assume  that  the  operating  expenses  in  any 
given  instance  are  normal,  possibly  making  some  slight  correc- 
tions by  additions  or  deductions  for  items  not  properly  charged 
and  then  accepting  such  operating  expenses  as  proper  and  un- 
worthy of  further  consideration.  The  acceptance  of  any  such 
principle,  while  not  affecting  the  value  of  the  property  being 
appraised,  does  not  recognize  the  difference  between  inefficient 
and  the  most  advantageous  management.  In  fact,  such  treat- 
ment of  operating  expenses  puts  a  premium  on  indolence,  ex- 
travagance and  inefficient  management,  because  there  is  no 
inducement  to  reduce  expenses  to  a  minimum,  or  to  seek  improved 
methods  that  will  make  "two  blades  of  grass  grow  where  one 
grew  before."  Efficiency  in  operation  should  be  rewarded  by 
allowing  a  rate  of  return  higher  than  normal,  but  that  is  distinct 
and  apart  from  foresight  or  sagacity  that  obtains  for  utility 
property  advantageous  conditions,  gifts  of  real  estate,  privileges 
or  rights  that  to-day  cannot  be  duplicated,  all  of  which  represent 
value  in  the  markets  of  the  world,  and  hence  are  a  part  of  the 
fair  value  on  which  rates  are  to  be  based.  Therefore,  while  the 
term  valuation  is  often  taken  to  relate  exclusively  to  property, 
tangible  or  intangible,  which  is  attained  through  the  expenditure 
of  money,  fair  values  should  recognize  not  only  the  value  of 
property  obtained  through  the  investment  of  cash,  but  also 
that  produced  by  the  effort  and  brain  capacity  of  corporation 
management. 

If  the  lowering  of  rates  for  service  to  the  public  is  the  only 
result  of  lower  cost  and  increased  efficiency — through  adapta- 
tion of  new  arts  and  methods  in  production,  the  application  of 
the  highest  business  acumen,  the  development  of  the  highest 
efficiency  among  the  employees  by  the  cultivation  of  an  unusual 
esprit  de  corps,  the  maintenance  of  physical  property  in  the  con- 
dition to  secure  best  economy — then  the  incentive  to  this  re- 
sult will  be  removed.  Investigators  of  the  results  of  govern- 
ment ownership  very  generally  agree  that  incentive  to  progress 


86  VALUE  FOR  RATE-MAKING 

is  largely  lost  through  failure  to  recognize  the  individual  efforts 
that  result  in  improved  service  or  efficiency  of  operation.  Proper 
rate-making  must  recognize  these  facts  and  reward  owners  and 
operators  of  public  utilities  in  proportion  to  their  interest, 
cooperation  and  success  in  rendering  improved  service^  with 
corresponding  efficiency. 

The  recognition  of  these  facts  may  complicate  the  basis  upon 
which  rates  are  to  be  determined,  but  that  can  hardly  be  used  as 
an  excuse  for  the  omission  of  this  very  important  element  in 
rate-making. 

The  efficiency  of  operation  must  be  determined  from  a  con- 
sideration of  the  existing  local  conditions  and  a  knowledge  of 
what  may  be  accomplished  by  the  use  of  intelligent  management 
employing  modern  methods.  The  efficiency  of  two  plants, 
identical  in  size,  equipment  and  managerial  skill,  may  be  quite 
different  under  different  conditions  of  loading.  Compare  two 
electric  light  plants,  one  of  which  with  a  load  factor  of  50  per 
cent,  is  enabled  to  produce  its  energy,  per  unit  delivered,  at  a 
very  much  lower  rate  than  a  second  plant  having  the  same  equip- 
ment, fuel,  employees  and  management,  but  with  a  load  factor 
of  25  per  cent.  There  are  actual  physical  conditions  and  laws 
which,  despite  the  clamor  of  the  public  for  reduced  rates  or  the 
utmost  endeavors  of  utility  management,  will  not  prevent  a 
higher  fair  rate  in  one  case  than  in  another.  Therefore,  effi- 
ciency of  management  ought  properly  to  be  considered,  de- 
termined and  rewarded  for  each  utility,  separately,  in  fixing  its 
rate  of  return. 

Value  of  Service. — Consideration  of  the  value  of  service  as  a 
factor  in  rate-making  is  not  a  new  theory.  One  of  the  more 
recently  inaugurated  State  Commissions  has  fully  discussed 
the  subject  and  approved  the  theory  in  the  following  illuminating 
statement: 

"In  short,  from  the  standpoint  of  what  traffic  will  bear,  a  sufficient 
and  legitimate  doctrine  if  properly  understood  and  circumscribed  but 
not  as  usually  urged  by  the  carriers,  the  apportionment  here  must  fall, 
for  the  limiting  maximum  rate  beyond  which  the  carrier  may  not  go 
and  hold  his  traffic  is  always  the  amount  the  patron  can  afford  to  pay, 
while  the  limiting  minimum  rate  below  which  the  carrier  cannot  afford 
to  do  the  business  is  the  actual  added  cost  to  the  carrier  of  sucli  business 
over  the  cost  which  such  carrier  must,  for  other  and  independent  reasons, 
incur.     In  short,  it  has  appeared  to  us  that  both  the  courts  and  com- 


FAIR  VALUE  FOR  RATE-MAKJXd  S7 

missions  have  been  in  error  in  determining  the  lowest  rate  that  a 
utility  may  reasonably  and  lawfully  afford.  This  rate,  the  courts  and 
commissions  to  the  contrary,  notwithstanding,  may  be,  and  often  is, 
below  the  actual  cost  of  performing  an  average  unit  service.  For 
example,  in  the  case  of  a  hydroelectric  company,  it  may  be  that  the 
actual  units  of  power  available,  cost,  unit  for  unit,  a  certain  amount  in 
actual  out-of-pocket  expenditure.  Therefore,  if  we  view  this  subject 
superficially,  we  would  immediately  say  that  this  company  could  not 
afford  to  furnish  its  commodity  at  a  less  rate  than  the  actual  out-of- 
pocket  cost  per  unit.  But,  on  inspection,  it  may  appear  that  by  reason 
of  the  impossibility  of  operating  in  every  instance  to  maximum  efficiency, 
there  is  excess  property  and  excess  expense  incurred  in  performing  the 
total  service  performed  at  any  one  time  which  will  not  be  ai^preciably, 
if  at  all,  increased  by  performing  some  additional  service.  Therefore, 
when  it  becomes  a  question  of  performing  or  not  performing  the  ad- 
ditional service,  under  the  circumstances  stated,  the  utility  does  not 
and  should  not  look  to  the  average  expense  of  performing  the  unit  of 
service,  but  look  to  the  added  cost  arid  the  added  revenue  alone,  which 
added  cost  may  be  much  less  than  the  average  cost  per  unit  and  which 
added  revenue  may  be  less  than  the  average  revenue  that  must  be  re- 
quired per  unit.  Therefore,  in  determining  whether  or  not  such  added 
business  shall  be  done,  the  considerations  we  have  herein  discussed  are 
the  ones  a  wise  economy  will  require  to  be  studied."^ 

The  Interstate  Commerce  Commission  has  recognized  this 
principle  in  its  decisions  where,  for  example,  it  says: 

"while  in  fixing  reasonable  rates  and  relative  rate  adjustments,  distance 
must  always  be  considered  as  bearing,  both  upon  cost  to  the  carrier 
in  performing  the  service  and  the  value  of  the  service  to  the  shipper. 
There  are  many  other  facts  such  as  density  or  sparsity  of  traffic  over 
and  along  the  lines  of  movement,  comparative  cost  of  construction  and 
operation,  and  competitive  conditions,  which  must  be  given  weight. "- 

"The  value  of  the  services  in  themselves  is  to  be  considered  and  not 
exceeded.  These  views  seem  to  be  consonant  with  reason.  They  are 
also  established  by  the  highest  judicial  authority  in  our  country."^ 

One  of  the  Massachusetts  commissions,  the  Board  of  Gas  & 
Electric  Light  Commissioners,  recognize  that  rates  may  have  to 
be  less  than  the  cost  theory  would  dictate,  in  order  to  secure  the 
business,  in  the  following  language : 

"The  company's  customers  may  be  broadly  divided  into  two  groups, 
those  who  are  dependent  upon  the  company  for  their  supply  and  those 

•  Southern  Pacific  Railway. 

^  Union  Tanning  Co.  vs.  Southern  Railway  Co.;  decided  Feb.  4,  1913. 

"  Kennebec  Water  District  vs.  City  of  Waterville  et  al,  97  Me.  210-202. 


88  VALUE  FOR  RATE-MAKING 

who  may  readily  supply  themselves  in  other  waj's  or  by  other  forms  of 
power.  To  the  first  the  company  may  dictate  the  price,  controlled 
only  by  motives  of  business  expediency,  its  own  sense  of  justice  and  its 
duty  as  a  public  servant.  To  the  second  the  company  must  so  fix 
the  price  as  to  secure  the  customer's  business  or  else  go  without  it. 
The  variety  and  wide  range  of  the  prices  offered  by  the  company  are 
ample  evidence  to  its  recognition  of  these  facts."^ 

The  Wisconsin  Commission  has  recognized  the  value  of  ser- 
vice as  an  element  in  fixing  rates,  authorizing  rates  for  service  in 
a  number  of  instances  at  less  than  cost  determined  from  a 
consideration  of  investment,  notably  in  the  Madison  Case,  where 
the  Commission  says: 

"The  contract  for  this  current  (sold  to  a  street  railway  company), 
was  taken  by  the  respondent  on  terms  that,  on  the  ordinary  basis  of 
figuring,  yield  very  little  in  the  way  of  profits.  In  fact,  it  appears  to 
have  been  taken  on  the  additional  cost  basis.  That  is,  the  respondent, 
in  taking  it,  based  its  conclusion  largely  on  the  increase  this  additional 
business  would  cause  in  its  operating  expenses.  It  apparently  had  to 
adopt  this  course  because  the  business  could  not  be  had  on  better  terms, 
and  on  the  theory  that  it  was  better  both  for  itself  and  the  rest  of  the 
consumers  to  take  on  the  street  railway,  even  if  the  income  from  it 
yielded  less  than  the  average  rate  of  return  on  the  investment."^ 

"The  demand  expense  for  the  station  was  apportioned  between  arc, 
incandescents,  power,  and  railway,  on  the  basis  of  the  average  demands 
on  the  station  by  each  of  these  four  branches  of  the  service  at  the  times 
of  the  maximum  demands  on  the  station  as  a  whole.  This  unit  was  used 
because  the  facts  indicate  that  it  appeared  to  be  logical  as  well  as  fair. 
The  output  expense  for  the  station  was  allotted  to  the  arc,  incandescent, 
and  power  on  the  basis  of  current  generated,  while  to  the  railway  it  was 
allotted  on  the  basis  of  the  cost  of  additional  business.  The  kilowatt- 
hours  of  current  generated  appear  to  be  the  proper  basis  upon  which  to 
apportion  output  costs,  while  the  additional  business  basis  can  only  be 
justified  under  special  or  rather  exceptional  conditions.     *  *  * 

"It  is  for  these  reasons,  mainly,  that  in  computing  the  cost  for  the 
railway'  department  we  confined  ourselves  mostly  to  such  expenses  as 
were  added  to  the  operation  of  the  respondent's  plant  by  taking  on  the 
business  of  the  street  railway.  This  basis  for  fixing  rates,  however,  has 
well-defined  limitations.  It  would  seem  that  it  can  be  justified  only  in 
cases  where  the  additional  business  can  be  had  on  no  better  terms  and 
where  these  terms  are  such  as  to  yield  something  in  the  way  of  profit 

'  Report  of  Board  of  Gas  and  Electric  Light  Commissioners  of  Massachusetts,  1913. 
State  Journal  Printing  Company  vs.  Madison  Gas  and  Electric  Company,  4  W.  R.  C.  R., 
page  670. 


FAIR  VALUE  FOR  RATE-MAKING  80 

and  are  not  unjustly  discriminatory.  That  it  would  not  he  sound 
practice,  from  the  point  of  view  of  either  business  or  puljlic  j)olicy, 
to  accept  such  additional  business  at  rates  that  would  not  cover  the 
additional  cost  of  taking  it  on,  when  this  cost  includes  ordinary  operat- 
ing items  which  are  affected,  together  with  taxes,  depreciation  and 
something  in  the  way  of  return  on  the  investment,  needs  no  argument. 
While  in  this  case  the  rate  paid  by  the  street  railway  company  is  low, 
it  is  probably  not  so  low  as  not  to  come  within  this  rule.  Had  the  street 
railway  been  charged  the  full  proportion  of  all  the  expense  items,  in- 
cluding taxes,  depreciation  and  interest,  but  omitting  general  expenses, 
the  cost  for  the  street  railway  on  the  basis  of  apportionment  used  here 
would  have  amounted  to  about  $30,232. "^  (Found  by  the  Com- 
mission, $19,254.99  Ed.) 

Both  the  Public  Service  Commission  of  Washington  and 
the  Supreme  Court  of  that  State  held  that  the  value  of  the 
service  must  be  considered  in  fixing  rates.  The  Commission  in 
a  recent  case  has  said : 

"In  this  case  as  in  all  rate  cases,  there  are  two  factors  wliich  must 
be  given  consideration,  to  wit:  'The  cost  of  furnisliing  the  service' 
and  'the  value  of  the  service  to  the  patron.'  What  we  have  said  thus 
far  bears  particularly  on  the  first  factor.  The  other  factor  cannot  be 
ignored  particularly  when  as  in  this  case  the  opinion  of  the  Railroad 
Commission  and  that  of  the  Supreme  Court  show  that  the  value  of  the 
service  to  the  patron  w^as  given  great,  if  not  controlling,  weight  by  the 
Railroad  Commission  in  making  the  orders  we  are  now  asked  to  vacate."* 

The  Supreme  Court  said: 

"Hence,  in  determining  the  reasonableness  of  railway'  rates,  con- 
sideration must  be  given,  not  only  to  the  carrier,  but  to  the  individual 
requiring  the  service.  The  company  is  entitled  to  adequate  recompense 
for  the  service  it  performs.  The  individual  is  entitled  to  a  rate  that 
he  can  reasonably  afford  to  pay  for  the  service  he  requires.  Upon  this 
point,  both  judicial  and  economic  authority  agree.     (Page  84.) 

"From  these  authorities,  the  true  rules  can  be  gathered,  that  rates 
can  go  no  higher  than  the  service  is  reasonably  worth  to  the  public 
requiring  the  service,  and  that  the  reasonable  value  of  the  service  to 
the  public  may  be  insisted  upon,  even  though  charges  so  limited  would 
fail  to  produce  a  fair  return  to  the  carrier  upon  its  investment."^ 
(Page  87.) 

>  State  Journal  Printing  Company  vs.  Madison  Gas  and  Electric  Company,  4  W.  R.  C.  R.. 
pages  665-6,  671. 

^The  Public  Service  Commission  of  Washington  vs.  Puget  Sound  Electric  Railway- 
cases  74-76,  page  118,  4th  Annual  Report  of  the  Public  Service  Commission  of  Washington. 

'  65  Washington  Reports  75. 


90  VALUE  FOR  RATE-MAKING 

Interest  and  Reward. — In  the  present  rapid  development  of 
the  principles  of  rate-making,  there  has  been  but  little  recogni- 
tion of  reward  or  profit  as  distinct  from  interest  on  the  value  of 
the  property  used  in  rendering  public  service.  Capital  lying 
idle  in  a  bank  is  normally  entitled  to  the  ruling  rate  of  interest 
in  the  particular  locality  in  which  the  capital  is  available,  but  a 
similar  payment  of  interest  upon  investment,  intelligently  and 
fairly  made  in  any  going  enterprise,  is  not  in  any  way  a  fair  return 
to  the  originators,  or  owners,  of  the  enterprise  in  payment  for 
their  making  such  investment,  assuming  the  risk  of  such  utility, 
and  displaying  the  ability  or  rendering  a  service  in  carrying  on 
such  business. 

Capital  is  entitled  to  a  definite  return  in  any  given  locality, 
regardless  of  its  use;  enterprise  results  in  efficient  handling  of 
capital  and  is,  therefore,  entitled  to  its  own  specific  reward, 
dependent  in  amount  upon  the  grade  of  efficiency  developed. 

In  considering  the  charges  that  should  properly  be  paid  by 
the  public  for  the  service  rendered  in  order  to  determine  rates, 
the  following  items  should  be  included : 

First. — Operating  expenses,  including  such  items  as  fuel,  labor, 
management  expenses. 

Second. — Taxes. 

Third. — Depreciation,  including : 

(a)  Ordinary  wear  and  tear. 

(&)   Renewals  and  replacements. 

(c)    Reserves  for  accruing  exhaustion  of  property. 

{d)  Inadequacy  and  obsolescence. 

Fourth. — Amortization,  or  sinking  funds,  where  necessary  to 
provide  for  the  extinguishment  of  investment,  as  in  the  case  of 
limited  franchises. 

Fifth. — Return  proper  for  local  conditions  on  the  value  of  the 
property  fairly  required  in  carrying  on  the  enterprise. 

Sixth. — Reward,  or  profit,  to  the  owners. 

It  has  been  customary  in  most  decisions  of  commissions  and 
courts  to  allow  merelj^  a  "fair  rate  of  return,"  upon  the  value  of 
the  property  including  in  the  rate  what  is  here  divided 
into  interest  and  profit.  The  trouble  with  this  procedure  of 
public  authorities  is  that  it  fails  to  properly  recognize  the  two 
classes  of  reward;  one  for  investment,  and  the  other  for  enter- 
prise. Both  rewards  are  usually  rolled  into  one,  too  rarely 
exceeding  a  fair  rate  of  interest. 


FAIR  VALUE  FOR  RATE-MA  KTXC  01 

The  fallacy  of  attempting  to  fix  the  rate  of  return  to  he  allitwcl 
a  public  utility,  merely  from  a  consideration  of  the  amount  of 
capital  expended,  would  mean  that  the  coiporation  with  the  most 
elaborate  and  costly  installation  would  be  entitled  to  the  largest 
revenues,  while  a  less  pretentious,  but  more  intelligently  planned 
and  economically  constructed  property,  doing  as  large  or  a 
larger  business,  would  in  effect  be  penalized  for  their  greater 
effectiveness  in  design  and  ability  to  attract  and  hold  business. 
Such  basis  of  valuation  would  moan  that  with  the  same  return 
allowed  upon  investment,  the  most  economically  constructed 
property  would  of  necessity  make  lower  tariffs,  and,  consequently, 
would  tend  to  secure  all  the  business,  leaving  the  more  costly 
property  without  sufficient  revenue  to  meet  even  operating  ex- 
penses. The  truth  of  this  line  of  argument  is  recognized  in  the 
making  of  steam  railroad  rates  to  competitive  points,  where 
the  amount  of  investment  is  not  made  the  basis  of  rates.  De- 
velopment and  initiative  ability  are  recognized  as  entitled  to 
rewards,  otherwise,  there  would  be  no  improvements,  or  any  in- 
ducement to  development  and  improvement. 

A  very  common  method  of  carrying  on  building  operations 
is  to  employ  a  contractor  who  is  paid  the  actual  cost  incurred  in 
purchase  of  materials,  labor  and  other  expenses  of  building  the 
structure,  plus  10  to  20  per  cent,  to  cover  the  cost  of  his  services, 
ability  and  management.  The  contractor  may  have  no  plant 
equipment  of  his  own,  or  in  any  case  his  investment  in  such  plant 
as  might  be  necessary  for  the  construction  of  the  property  in 
question  would  be  but  a  relatively  small  amount,  and  a  return 
on  such  contractor's  plant  would  in  no  way  compensate  him  for 
his  time  and  ability.  The  contractor  is  paid  his  percentage  on 
the  amount  of  his  "turn-over;"  that  is,  the  sum  of  the  expendi- 
tures made  for  material  and  labor  in  completing  the  structure. 

A  reward,  which  may  properly  be  called  a  "commission." 
based  upon  the  amount  of  business  done,  that  is,  ujjon  \ho 
revenue,  permits  a  uniformly  applicable  and  exact  ascertain- 
ment of  that  reward  wdthout  regard  to  the  amount  of  capital 
invested.  By  way  of  illustrating  one  set  of  conditions,  take 
the  case  of  two  non-competing  utilities  having  the  same  amount 
of  annual  gross  revenue,  they  would  be  allowed  the  same  rate, 
or  percentage  as  commission,  on  account  of  the  business  done. 
Assuming  that  one  of  the  utilities  is  required  by  the  necessity  ()f 
its  business  to  invest  a  large  amount  of  capital  as  compared  witii 


92  VALUE  FOR  RATE-MAKING 

the  other,  then  both  will  be  allowed  (under  the  same  local 
conditions)  the  same  rate  of  return  upon  the  capital  invested, 
but  the  company  having  the  greater  capital  investment  receives 
a  total  aggregate  amount,  as  its  annual  return,  larger  than  the 
other  company,  which  is  both  fair  and  reasonable.  If  the 
conditions  are  different,  both  utilities  having  property  of  equal 
value,  but  the  first  does  twice  the  annual  business  of  the  second, 
then  the  rate  of  return  on  capital  being  the  same,  the  aggregate 
amount  received  annually  by  each  as  interest,  is  the  same,  but 
the  commission  received  by  the  first  utility  will  be  twice  that 
received  by  the  second,  both  being  allowed  the  same  rate  or 
percentage  on  their  gross  revenue,  thus  the  second,  by  reason 
of  more  effective  utilization  will  receive  the  greater  gross  re- 
turn. For  the  sake  of  simplicity,  no  mention  has  been  made,  in 
the  preceding  illustrations,  of  the  profit  which  should  or  should  not 
be  allowed  the  utilities,  but  which,  of  course,  must  be  inde- 
pendently considered  and  determined.  It  may  well  be  that  while 
interest,  profit  and  commission  are  each  fixed  separately  for 
any  given  utility,  their  sum  may  actually  or  approximately 
equal  the  sum  of  like  allowances  for  another  and  different 
utility,  that  is  no  reason  why  each  case  should  not  be  logically 
and  equitably  decided  upon  its  own  considerations,  for  "there 
is  no  necessary  relation  between  a  7  per  cent,  return  on  capital, 
and  a  10  per  cent,  return  on  income." 

The  proposal  to  analyze  and  divide  into  its  components  the 
total  reward  to  be  allowed  utilities,  may  at  first  sight  seem  com- 
plex and  unnecessary,  but  in  order  to  insure  justice  and  a  proper 
consideration  of  all  elements  making  up  the  rate  of  return,  it 
is  believed  the  separation  of  interest  as  distinct  from  profit,  and 
both  from  commission,  permits  a  clearer  appreciation  of  what 
is  being  considered,  makes  easier  a  comparison  with  what  corre- 
sponds to  rewards  allowed  in  ordinary  commercial  transactions, 
and  allows  a  fairer  determination  of  the  amount  of  return  proper 
for  each  class  of  service. 

"To  illustrate  a  rational  method  of  determining  reasonable  profits, 
let  us  take  the  steam  railways  of  America,  and  let  us  assume  that  the 
capital  invested  in  their  construction  and  equipment  is  $45,000  per  mile 
of  roadbed.  Then,  according  to  data  given  in  the  Interstate  Commerce 
Commission  Report  for  the  year,  190G,  and  upon  this  assumption  of 
first  cost,  we  have: 


FAIR  VALUE  FOR  RATE-MAKING  93 

Per  mile  of  road 

Operating  expense  (including  renewals) SG.SiXi 

Taxes 337 

Interest  on  $45,000  at  43-^  per  cent 2,025 

Total  cost  of  production $9,258 

Operating  revenue 10,460 

Deduct  cost  of  production 9,258 

Profit $1,202 

"This  profit  is  about  U^  per  cent,  of  the  operating  revenue.  It 
is  not  quite  2.7  per  cent,  of  the  assumed  investment  of  $45,000  per  mile. 
Hence  the  total  return  on  capital — viewing  the  matter  from  the  old 
standpoint — is  2.7  per  cent,  profit  and  plus  4.5  per  cent,  interest  =  7.2 
per  cent. 

"It  may  chance,  therefore,  that  a  7  per  cent,  'return  on  capital'  in- 
vested in  railways  gives  a  true  profit  of  10  or  11  per  cent,  on  gross  income, 
and  that  this  return  is  reasonable  in  that  such  managerial  ability  is 
suitably  rewarded  by  its  10  per  cent,  profit;  but  there  is  no  necessary 
relation  between  a  7  per  cent,  'return  on  capital'  and  a  10  per  cent, 
return  on  income."^ 

As  indicating  other  elements  than  mere  value  of  property  or 
investment,  mention  is  made  of  the  following  considerations  that 
should  be  given  weight  in  steam  railroad  rate-making. 

Economies  and  lower  rates  for  service  have  resulted  from 
developments,  improvements  and  inventions  that  must  be 
credited  to  aggressive,  efficient  management;  for  example,  the 
use  of  large  freight  cars  has  amply  demonstrated  their  economy. 
Fifty  years  ago,  a  15,000-lb.  freight  car  indicated  what  was  normal, 
whereas  the  present  representative  cars  have  a  capacity  of  from 
80,000  to  100,000  lb.  This  means  that  very  much  greater  carrj^- 
ing  capacity  is  obtained  by  a  comparatively  small  increase,  not 
only  in  operating  expenses,  but  also  in  fixed  charges,  which  are 
a  relatively  much  smaller  investment  per  unit  transported. 
Train  loads  which  for  long  hauls  may  now  be  perhaps  con- 
sidered standard  at  2,000  tons  were  almost  unthought  of  only 
a  dozen  or  fifteen  years  ago.  The  economy  of  all  locomotive 
operation  has  been  largely  improved  during  the  last  10  or  20 
years  due,  not  only  to  improved  efficiency  and  power  of  the 
locomotives  themselves,  but  by  reason  of  their  more  intensive 
use,  resulting  from  better  and  more  intelligent  supervision. 

^Engineering-Contracting,  May  25,  1910  (pages  467-8),  pertaining  to  "A  rational 
method  of  determining  reasonableness  of  rates  charged  by  Public  Service  Corporations  and 
a  discussion  of  the  theory  of  profits." 


94  VALUE  FOR  RATE-MAKING 

As  illustrating  the  reductio  ad  absurdum  to  which  the  stead- 
fast and  logical  adherence  to  the  principle  of  allowing  returns  on 
only  the  value  of  physical  property,  the  decision  of  the  Rail- 
road Commission  of  California,  in  the  matter  of  rates  of  charges 
authorized  the  Wells  Fargo  Express  Company,  is  illuminating. 

The  capital  invested  in  the  physical  property  of  the  express 
companies  is  relatively  small  compared  with  the  service  rendered 
or  the  gross  revenue  received  therefrom,  because  the  transporta- 
tion is  done  mainly  by  the  railways.  The  recent  decision  of  the 
Interstate  Commerce  Commission  seriously  reducing  all  express 
rates  seems  to  have  failed  in  making  due  allowance  for  the  reward 
for  service.  The  same  views,  that  return  on  the  value  of  the 
physical  property  only,  should  be  allowed  the  express  companies, 
is  shown  by  the  recent  decision  of  the  Railroad  Commission  of 
California. 

This  Commission  in  determining  the  revenue,  operating  ex- 
penses, net  income  and  value  of  the  physical  property,  of  the 
Wells  Fargo  Express  Company  used  for  intrastate  business  in 
California,  in  1911,  arrived  at  the  following  figures: 

Gross  revenue $4,508,436 

Operating   expenses,    payments   to    railroads   for 

transportation 1,937,019 

Terminal  expenses 1,343,108 

Overhead  expenses 89,733 

Line   expenses 294,127 

Miscellaneous 266,027 

$8,438,450 
Less  deductions 105,745 

$8,332,705 
Net  income 684,165 

$7,648,540 

In  arriving  at  the  above  figures,  showing  a  net  income  of 
$684,105,  more  or  less  arbitrary  assumptions  were  made  as  to  the 
division  of  expenses  of  an  interstate  and  intrastate  business. 
On  the  basis  of  certain  other  assumptions  the  Commission  found 
the  net  income  from  intrastate  business  to  be  $842,097  and  upon 
still  slightly  different  assumptions  it  found  the  net  income  to 
be  $695,691.  From  a  consideration  of  these  three  results  and 
the  value  of  the  physical  property  as  found  by  it  to  be  $613,233, 


FAIU  VALUE  FOR  RATE-MAKING  <»-) 

the  Commission  concludod  that  $61,323  should  be  taken  as  the 
fair  net  income  from  intrastate  business  properly  allowable  U)y 
the  year  1911,  concluding  with  the  following: 

"We  have  already  found  that  the  net  revenue  from  California  intra- 
state transportation  business  during  the  year  here  considered  was  not 
less  than  $684,165.90,  which  represents  a  little  more  than  111  per  cent, 
of  the  total  value  of  the  company's  property  devoted  to  the  public 
service  in  this  State,  conceding  to  the  company  practically  everything 
it  asks;  or,  taking  the  second  method  of  apportionment,  the  net  earning 
is  in  excess  of  136  per  cent. 

"Allowing  the  company  10  per  cent,  on  the  basis  of  valuation  of  its 
property  of  $613,233.85  gives  a  charge  of  $61,323.39  as  the  earning  to 
which  the  express  company  is  entitled  after  paying  all  of  its  operating 
expenses,  taking  care  of  depreciation  and  all  charges  necessary  and 
proper  in  the  conduct  of  its  express  business,  and  we  shall  prescribe 
rates  which  will  allow  the  express  company  all  of  its  charges  to  the 
railroads,  its  legitimate  operating  expenses,  all  of  its  other  legitimate 
charges,  including  depreciation,  and  $61,323.39  as  a  net  earning  upon  its 
property."^ 

On  the  basis  of  the  above,  the  Commission  ordered  the 
company  to  put  in  force  a  schedule  of  rates,  or  tariffs,  promul- 
gated by  the  Commission,  which  were  planned  to  reduce  revenue 
in  line  with  the  above  quotation. 

The  reasonableness  of  attempting  to  fix  a  net  income  of 
$61,323  as  being  a  fair  return  merely  on  a  physical  property  may 
be  questioned  when  it  is  considered  that  this  sum  is  obtained 
by  approximate  methods  and  based  on  revenues  of  over 
$4,500,000.  In  ordinary  engineering  calculations  1  j^er  cent,  is 
considered  so  small  an  item  as  to  be  practicably  negligible,  yet 
a  reduction  in  the  net  income  of  the  express  company  of  less 
than  13-^  per  cent,  would  entirely  wipe  out  all  return  to  the 
owners  for  the  use  of  their  property.  The  net  income  from 
intrastate  business  was  found  to  be  as  small  as  $684,165,  or 
as  large  as  $842,097,  depending  on  the  methods  used;  a  varia- 
tion of  $157,932,  evidently,  merely  an  approximate  figure,  yet 
no  reward  was  considered  necessary  for  the  business  acumen, 
ability  or  the  "going  value"  of  the  corporation,  which  peruiits 
it  to  develop  a  business  having  a  revenue  of  over  $4,50(),()()(). 
Such  slight  margin  as  $61,323  on  a  revenue  of  $4,508,436,  is  so 

1  Report  of  Railroad  Commission  of  California,  Decision  No.  841,  In  the  Matter  of  tlip 
Schedules  or  Tariffs  of  Rates  of  Charges  of  Wells  Fargo  Co.,  Case  No.  122. 


96  VALUE  FOR  RATE-MAKING 

small  and  is  so  likely  to  be  jeopardized  by  absolutely  uncan- 
troUable  variations  in  business  that  the  regulation  of  utilities 
on  any  such  basis  must  result  not  only  in  the  refusal  of  addi- 
tional capital  to  enter  such  enterprises,  but  the  confiscation 
of  present  invested  capital  and  confidence. 

The  impossibility  of  determining  proper  tariffs  from  a  con- 
sideration merely  of  the  value  of  the  property  used  in  render- 
ing the  service  is  recognized  by  the  Railroad  Commission  of 
Wisconsin,  which,  perhaps,  as  much  as  any  other  Commission 
or  public  authority,  is  definitely  committed  to  the  use  of  the 
value  of  the  property  used  in  fixing  rates. 

"It  has  also  been  the  contention  of  representatives  of  localities  along 
certain  lines,  and  even  along  sections  of  such  lines,  comprising  the  entire 
interurban  system,  that  the  patrons  of  those  separate  lines  or  sections 
of  lines  having  a  higher  traffic  density  and  operating  upon  a  better 
revenue  basis  should  be  granted  fares  lower  than  the  fares  computed 
upon  a  mileage  basis.  It  is  difficult,  however,  to  see  the  justice  of  es- 
tablishing such  fares,  especially  when  it  is  the  object  of  this  revision  of 
existing  rates  to  abolish,  so  far  as  practicable  for  the  present,  all  special 
fares  involving  local  discrimination.  It  is  also  the  object  of  this  revision 
of  rates  to  bring  about  simplicity,  uniformity  and  stability  in  the 
rate  schedules  applying  to  these  lines  by  disregarding  any  differences  in 
revenues  or  operating  conditions.  This  is  in  line  with  the  more  modern 
theory  of  transportation  rates.  Take,  for  example,  the  regular  passenger 
fares  upon  the  steam  lines  within  the  state.  The  basic  rate  is  2  cts. 
per  passenger  mile  and  with  few  exceptions  the  fares  are  computed 
accordingly  whether  the  company  is  large  or  small,  whether  the  haul 
is  long  or  short,  whether  the  traffic  is  profitable  or  unprofitable,  or 
Avhether  the  service  is  poor  or  excellent.  If  all  these  factors  cited  should 
be  reflected  in  full  force  in  the  rates  the  probability  is  that  the  rates 
would  vary  all  the  way  from  0.5  ct.  per  mile  to  50  cts.  per  mile.  But 
the  nature  of  the  transportation  business  is  such  that  the  demand  for 
complicity,  uniformity  and  stability  is  necessarily  controlling  because 
even  a  slight  variation  in  basic  rates  would  open  the  way  to  uncertainty 
in  the  minds  of  the  riding  public  and  would  result  in  personal  and  local 
discrimination."' 

While  in  every  case,  where  the  rendition  of  service  is  concerned, 

the  greatest  use  of  property,  reasonably  obtainable,  should  be 
required,  yet  a  difference  in  the  habits  of  the  citizens,  the  number 
and  type  of  manufacturing  concerns,  and  other  local  conditions 

•  Opinion  and  decision  of  Railroad  Commission  of  Wisconsin,  Robert  S.  Schmieder  et  al. 
VB.  Milwaukee  Light,  Heat  &  Traction  Co.,  decided  Jan.  2,  1914.  13,  W.  R.  C.  R.,  489. 


FAIR  VALUE  FOR  RATE-MAKING  07 

prevent  the  establishment  of  a  minimum  "load  factor"  as  uni- 
formly attainable,  and  compels  its  determination  in  each  in- 
dividual case.  To  further  illustrate  the  unicjue  condit.icjns 
which  control  considerations  on  which  to  base  reward,  take  I  ho 
case  of  an  actual  electric  light  and  power  utility,  which  origi- 
nally located  its  generating  station  convenient  to  a  railroad, 
where  there  was  an  available  supply  of  water  that  seemed 
ample  for  years  to  come;  with  the  development  of  the  business 
over  a  period  of  15  years,  additions  and  extensions  to  the  power 
plant  were  made  without  unreasonable  accretions  in  cai)it;il 
account.  But  as  the  result  of  progressive  management,  con- 
centrated business-getting  methods  and  the  continued  greater 
use  of  electrical  energy  on  the  part  of  the  public,  the  demand 
upon  the  power  station  passed  beyond  the  limit  of  maximum 
utilization  of  the  original  plant  and  its  water  supply,  making 
necessary  the  construction  of  a  new  station  at  a  different  site 
where  there  was  an  unlimited  supply  of  water,  and  where  the 
now  developed  demand  for  electrical  energy  warranted  the 
building  of  a  spur  track  to  be  used  exclusively  for  the  new 
power  plant.  The  new  plant  has  cost  in  the  aggregate  nearly 
$1,000,000,  and  has  rendered  useless  the  old  investment  amount- 
ing to  $600,000.  Therefore,  the  proper  charges  to  be  borne  by 
the  public  for  similar  service,  must  now  be  based  on  the 
$1,000,000  investment,  whereas  slightly  less  demands  on  the  part 
of  the  public  permitted  them  to  pay  similar  charges  on  only 
a  $600,000  investment. 

In  the  case  of  a  steam  railroad  handling  a  given  amount  of 
business  well  below  its  maximum  capacity,  it  may  add  small 
increments  of  traffic  with  no  increase  in  charges  for  capital  ac- 
count, and  with  but  small  increase  in  maintainance  and  operating 
expenses:  first,  simply  by  better  loading  without  any  noticeable 
increase  in  the  sum  total  of  its  annual  charges;  second,  by 
slightly  increasing  the  frequency  of  the  service,  with  somewhat 
larger  expenses  for  fuel  and  wages,  a  still  greater  and  substantial 
increase  in  the  amount  of  business  can  be  obtained.  This  in- 
crease of  effective  utilization  can  continue  up  to  a  certain  point, 
when  additional  locomotives  and  cars  must  be  provided  and 
finally  a  point  is  reached  where  it  is  necessary  to  add  additional 
right-of-way  and  very  materially  add  to  the  capital  account 
with  consequent  increase  in  fixed  charges.  Up  to  the  point 
where  there  is  no  substantial  additional  outlay  of  capital,  effi- 
7 


98 


VALUE  FOR  RATE-MAKING 


ciency  of  utilization  of  the  property  is  steadily  increasing  with 
increase  of  business,  but  when  such  efficiency  has  reached  its 
maximum,  requiring  large  additional  outlays  for  new  plant,  the 
efficiency  may  drop  to  a  low  figure,  and  this  result  is  due  entirely 
to  the  fact  that  the  business  has  increased  to  just  beyond  the 
limits  of  the  capacity  of  the  original  property.  Thus,  at  the 
point  of  maximum  utilization  the  rates  that  would  pay  more  than 
a  fair  return — even  a  handsome  profit  to  the  investors — will  be 
found  inadequate  to  make  a  fair  return  and  may  even  show  a 
deficit  after  the  expenditure  for  the  additional  property  invest- 
ment required  by  a  relatively  small  increase  in  business,  beyond 
the  capacity  of  the  original  property.  Consequently,  it  will  be 
seen  that  the  largest  tonnage  per  mile  that  a  railroad  can  safely 
and  effectively  crowd  on  to  its  line  will  result  in  the  lowest 
charges,  at  the  same  time  affording  proper  return  to  the  investors. 

In  steam  railroad  operation  where  a  large  proportion  of  the 
total  charges  are  constant,  irrespective  of  the  amount  of  business 
done,  the  fixing  of  rates  on  whatever  basis,  particularly  where 
large  consideration  is  given  to  the  value  of  the  physical  property 
alone,  may  result  in  confiscation,  unless  the  business  conditions 
of  the  country  at  large  are  considered  when  fixing  the  rates. 

To  illustrate  the  unfairness  of  ignoring  the  principle  of  re- 
warding enterprise  in  fixing  rates,  consider  two  communities, 
"A"  and  "B"  similarly  situated,  each  having  a  population  of 
50,000.  "A"  has  a  live,  progressively  managed  electric  utility 
with  up-to-date  commercial  methods.  "B"  has  similar  equip- 
ment, so  far  as  apparatus  is  concerned,  but  it  does  not  appre- 
ciate the  possibilities  of  the  business.  Therefore,  the  practical 
results  of  operation  are  shown  in  the  following  tabulation: 

Table    I 

A  B 


Capital  invested , $1,57.5,000 .  00 


Average  sales  rate  {>er  watt-hour 

Sales  per  capita 

Gross  earnings 

Operating  expense  (ratio  60  per  cent.) 

Earnings  applicable  to  interest  and  taxes. .  .  . 
Taxes  on  the  basis  of  $5  per  huiulrod  gross 

earnings 

Earnings  applicable  to  dividends 

Per  cent,  equivalent  on  capital  invested 


0 .  04 

8.00 

400,000.00 

240,000 .  00 

160,000.00 

20,000 . 00 
140,000.00 

8.7 


,125,000.00 

0.06 

5.00 

250,000 .  00 

150,000.00 

100,000,00 

12,. 500. 00 
87,500.00 

7.7 


FAIR  VALUE  FOU  UATE-MAKl Ml 


'.I'.) 


"A"  has  used  10,000,000  kilowatts  per  aiuiuiii,  while  "li"  lias  lia<l 
the  benefit  of  only  4,106,000.  "A"  has  received  in  taxes  $20,000, 
while  "B"  has  received  $12,500.  In  other  words,  "A"  receives  its 
service  at  33^  per  cent,  less  than  "IV  and  is  well  served  and  well 
satisfied,  while  "B"  is  not  satisfied  wdth  either  its  service  or  its  rates, 
although  the  capital  invested  in  the  enterprise  is  receiving  a  less  return 
than  that  invested  in  "A." 

The  conditions  cited  are  not  at  all  exaggerated,  and  the  repcjrts  of 
the  Public  Service  Commission  for  the  last  six  years  will  show  similar 
cases. 

Let  us  assume  in  the  example  cited  above  that  the  Commission  stands 
on  the  ruling  that  all  companies  shall  be  allowed  to  earn  8  per  cent, 
and  no  more.  "A"  has  in  this  case  a  return  of  %q  per  cent,  greater 
than  it  should  have,  although  it  is  furnishing  nearly  two  and  a  half 
times  the  service  and  at  one-third  less  rate  than  "B,"  and  is  paying 
$7,500  more  per  annum  in  taxes.  "B's"  rate  under  the  same  ruling 
is  too  low,  and  should  be  raised  sufficiently  to  bring  in  a  return  of  8  per 
cent,  on  the  capital  invested. 

Until  the  present  era  of  public  utility  regulation,  the  theory 
has  never  received  serious  consideration  that  dollars  invested, 
practically  without  regard  to  the  human  ingenuity,  efficiency 
and  industry  expended  thereon,  should  be  made  the  measure  of 
reward.  To-day,  however,  there  are  many  advocates  of  this 
theory,  and  courts  and  commissions  are  holding  that  the  value 
of  the  property  entitles  the  owner  to  a  rate  of  return,  without 
reference  to  whether  the  owner  uses  that  value  indolently  or 
aggressively.  Much  present-day  thinking  in  relation  to  utilities 
seems  to  have  lost  sight  of  the  fact  that  the  ability  to  do  business 
and  render  service  is  entitled  to  reward,  even  though  there  be 
little  or  no  property  employed  therein.  Yet,  in  practically  all 
other  lines  of  business,  such  rewards  are  conceded. 

A  merchant  figures  his  profit  on  a  percentage  of  the  sales, 
not  upon  the  value  of  his  stock  on  hand.  He  turns  over  his  stock 
several  times  each  year  and  the  more  times  that  he  can  turn  it 
over,  the  greater  his  profit,  and  this  is  as  it  should  be,  because 
"the  harder  money  is  made  to  work"  the  greater  should  be  the 
reward  to  the  owner. 

'  J.  T.  Hutchings,  General  Manager,  Rocliester  Railway  &  Light  Company,  before  the 
New  York  State  Waterways  Association,  June,  1914. 


CHAPTER  V 
COST  OF  REPRODUCTION 

Development  of  Theory. — A  consideration  of  the  conflicting 
views  and  many  theories  promulgated  for  determining  value 
leads  many  a  practicable  mind  to  turn  to  actual  cost  in  money 
as  the  proper  measure  of  value.  To  the  lay  mind  it  would  seem 
as  if  the  basis  for  rates  might  well  be  made  the  amount  of  money 
expended  for  the  benefit  of  the  public.  But  it  will  be  imme- 
diately recognized  that  a  part  of  the  money  spent  may  have  been 
expended  recklessly,  improperly,  or  for  property  which  is  no 
longer  in  existence.  A  common  experience  will  indicate  that 
cost  does  not  necessarily  indicate  present  value.  Present  value 
may,  on  the  one  hand,  be  much  less  than  cost  if  property  has  been 
allowed  to  depreciate,  has  been  injured  by  accident,  exhausted 
by  service  or  wrecked  by  mismanagement,  on  the  other  hand,  it 
may  be  more  than  cost  if  property  has  increased  in  value  through 
appreciation  of  real  estate,  improvement  of  operating  conditions, 
superior  management  or  desirable  location.  As  a  matter  of 
fact  the  greater  the  separation  in  point  of  time,  between  cost  and 
the  date  of  valuation,  the  greater  the  difference  may  be  between 
expenditure  and  value.  When  the  date  of  cost  and  the  date  of 
value  to  be  determined  are  the  same,  expenditure  honestly  and 
intelligently  made  is  a  fair  measure  of  value.  This  latter  con- 
sideration has  lead  to  the  very  general  acceptance  of  the  cost  of 
reproduction  theory  in  determining  the  present  value  of  any 
property. 

It  is  a  method  universally  applicable  for  determining  the 
existing  or  present-day  value  of  utility  property,  because  it 
furnishes  an  estimate  of  the  cost  of  producing  a  like  property  at 
to-day's  costs. 

"Reproduction  cost  is  based  upon  the  assumed  recreation  or  sub- 
stitution of  an  identical  new  plant  at  present  prices  according  to  the 
existing  apparatus,  specifications,  assuming  reasonable  diligence  and 
methods  and  a  reasonable  period  of  time  in  construction.  "^ 

'  Mr.  W.  H.  Blood,  testimony  before  Public  Service  Commission  of  Missouri,  October, 
1913. 

100 


COST  OF  REPRODUCTION  ]n\ 

An  attempt  to  ascertain  present  value  by  modifying  tin- 
figures  of  original  cost  or  investment  to  meet  one's  ideas  of  tlu' 
cost  of  existing  property  is  no  less  speculative  or  theoretical  than 
the  determination  of  present  value  by  using  present-day  prices 
applied  to  existing  property.  On  account  of  this  practical 
difficulty  of  modifying  original  cost  and  because  of  the  absence 
or  indefiniteness  of  old  records  the  method  of  using  to-day's  cost 
for  pricing  property  has  been  quite  generally  taken  and  accepted 
as  the  most  important  element  to  be  considered  in  determining 
the  value  of  existing  utility  property. 

"The  cost  of  reproduction  of  tangible  property  is  at  present  the  most 
generally  accepted  basis  of  valuation  for  purchase  or  rate-making. 
Its  great  advantage  is  that  it  is  comparatively  easy  of  ascertainment."' 

"Reproduction  cost  new  is  the  basis  upon  which  substantially  all 
modern  appraisements  are  made.  It  is  the  most  fair,  from  the  fact 
that  it  is  based  upon  existing  conditions  and  it  is  not  especially  difficult 
to  determine  market  prices  for  materials  and  labor  at  the  time."^ 

The  cost  of  reproduction  method  has  been  used,  with  some 
differences  as  to  detail  methods  and  unit  prices,  both  by  the 
experts  for  public  authorities  and  the  appraisers  employed  by 
the  corporations  in  ascertaining  the  present  value  of  utility 
properties.  The  courts  themselves  have  sustained  and  approveil 
this  method.  The  Supreme  Court,  in  the  Knoxville  Water 
Company  case,  said: 

"The  cost  of  reproduction  is  one  way  of  ascertaining  the  present 
value  of  a  plant  like  that  of  a  water  company."' 

The  method  was  also  used  in  the  Consolidated  Gas  case  where 
the  value  thus  arrived  at  was  made  the  basis  of  rates  approved 
by  the  Supreme  Court.  In  the  more  recent  Minnesota  rate  case 
the  Supreme  Court  said: 

"The  cost  of  reproduction  method  is  of  service  in  ascertaining  tlie 
present  value  of  the  plant,  when  it  is  reasonably  applied  and  when  the 
cost  of  reproducing  the  property  may  be  ascertained  with  a  proper 
degree  of  certainty."^ 

The  Supreme  Court  of  Idaho  has  recently  upheld  the  methods 
of  the  State   Utilities  Commission  in  using  the   reproduction 

>  Whitten,  "Valuation  of  Public  Utilities,"  Sec.  639. 

^Foster,  "Engineering  Valuation  of  Public  Utilities  and  Factories,"  page  14. 

3  City  of  Knoxville  vs.  Knoxville  Water  Co.,  212  U.  S.  9. 

*  Minn.  Rate  Cases,  230  U.  S.  452. 


102  VALUE  FOR  RATE-MAKING 

method  for  ascertaining  the  vaUie  of  iitihty  property  in  rate- 
making,  the  Court  saying: 

"This  Court  is  of  the  opinion  that  the  rule  of  cost  of  reproduction 
less  depreciation,  adopted  by  the  commission,  is  the  correct  general 
rule  or  principle  to  be  applied  in  this  class  of  cases. "^ 

The  Court  then  goes  on  to  state  that 

"The  worth  of  a  new  plant  of  equal  capacity,  efficiency  and  durability 
*  *  *  should  be  the  measure  of  value,  rather  than  the  cost  of  exact 
duplication." 

explaining  that  the  only  deduction  for  depreciation  should  be 
for 

"actual,  tangible  depreciation,  and  not  for  theoretical  depreciation, 
sometimes  called  'accrued  depreciation.'  " 

Perhaps  the  best  considered  declaration  on  the  subject  of  using 
reproduction  cost  as  the  best  evidence  of  present  value  is  the 
Federal  Court's  decision  in  the  Louisville  Railroad  case.  It 
involved  the  constitutionality  of  an  act  of  the  legislature  in 
establishing  railroads'  rates,  and  hence  is  a  rate  case.  Speaking 
on  the  subject  of  reproduction  cost,  the  Court  says: 

"In  reference  to  the  question  of  value  with  the  view  of  rate  regulation, 
the  most  reliable  test  ordinarily  is  the  cost  of  the  reproduction  of  the 
road  as  it  exists.  *  *  *  The  original  cost  of  a  road  may  in  some  cases  re- 
flect light  on,  or  even  determine,  the  present  value,  as  when  it  is  of  very 
recent  construction.  But  ordinarily  it  is  of  little  assistance  in  that 
regard,  since  many  items  of  value  may  be  donations  by  the  government, 
or  by  individuals,  as  in  the  case  of  the  south  and  north,  or  the  road  may 
have  been  built  long  before  the  period  of  inquiry  at  greatly  less  or  greatly 
higher  prices  than  those  prevailing  at  the  time  of  the  inquiry.  Or 
its  original  cost  might  be  involved  in  obscurity  and  may  include  the 
cost  of  abandoned  or  destroyed  portions  of  the  property,  which  should 
not  figure  in  the  inventory  for  the  present  time,  or  the  road  may  have 
been  bought  at  a  forced  sale  in  times  of  panic  at  a  nominal  price  or  in 
inflated  times  at  a  corresponding  price;  or  the  road,  costing  little  origi- 
nally, may  have  developed  from  many  contributing  causes  into  being 
property  of  great  value.  And  in  every  case,  after  finding  the  original 
cost,  when  possible  to  be  done,  the  question  would  still  have  to  be  solved 
as  to  whether  .such  original  cost  is  the  same  as  the  present  value,  which 
would  involve  the  determination  of  the  present  value  for  such  com- 

'  Murray  vh.  Puhlio  I'tilities  Cornrnis.sioii,  ISO  Pufific  Itcportcr  ,50. 


rrXST  OF  REPRODrcTloX  ]():i 

parison  independent  of  original  cost,  and  in  no  other  or  hettor  way  tlmii 
on  reproduction  values."' 

"It  is  a  fair  return  upon  the  reasonable  value  of  their  Minnesota 
property  in  1908  to  which  these  companies  were  entitled,  and  the  cost 
of  that  property  at  times  varying  from  5  to  40  years  ago  may  be  some 
evidence,  but  it  is  certainly  no  criterion  of  its  value  in  that  year.  In 
view  of  these  facts  the  master  rightly  decided  that  the  cost  of  reproduc- 
ing this  property  new  was  a  more  rational  and  reliable  measure  of 
its  real  value  than  the  original  cost  of  its  acquisition  and  construction 
or  the  market  values  of  the  stocks  and  bonds  of  the  companies  and 
upon  such  basis  he  made  his  findings. "^  • 

In  the  Consolidated  Gas  Company  case  where  the  cost  of 
reproduction  was  made  the  basis  of  value  upon  which  rates  were 
fixed,  Judge  Hough,  in  the  course  of  his  opinion,  gave  his  idea 
of  the  cost  of  reproduction  as  related  to  value  in  the  following 
clear  language: 

"It  appears  by  undisputed  evidence  that  some  of  these  last  items  of 
property  cost  more  than  new  articles  of  the  same  kind  would  have  cost 
at  the  time  of  inquiry;  that  some  of  designs  not  now  favored  by  the 
scientific  and  manufacturing  world,  so  that  no  one  now  entering  upon  a 
similar  business  would  consider  it  wise  to  erect  such  machine  or  obtain 
such  apparatus.  In  every  instance,  however,  the  value  assigned  in  the 
report,  is  what  it  would  cost  presently  to  reproduce  each  item  of  property 
in  its  present  condition  and  capable  of  giving  service  neither  better 
nor  worse  than  it  now  does."     (Page  854.) 

"As  to  all  of  the  items  enumerated,  therefore,  from  real  estate  to 
meters,  inclusive,  the  complainant  demands  a  fair  return  upon  the 
reproductive  value  thereof,  which  is  the  same  thing  as  the  present 
value  properly  considered.  To  vary  the  statement:  Complainants' 
arrangements  for  manufacturing  and  distributing  gas  are  reported  to 
be  worth  the  amounts  above  tabulated  if  disposed  of  (in  comniercinl 
parlance)  'as  they  are.' 

"Upon  authority,  I  consider  this  method  of  valuation  correct.'"^ 
(Page  855.) 

"The  great  and  substantial  question  of  fact,  in  this  case,  is  as  to 
the  value  of  the  plant.  What  a  plant  cost  originally  is  not  the  measure 
of  value  that  courts  must  look  to,  to  determine  the  validity  of  rates. 
The  value  of  stocks  and  bonds  is  no  test,  for  obvious  reasons,  and 

1  Louisville  &  N.  R.  Co.  vs.  Railroad  Commission,  196  Fed.  820. 

2  Shepard  vs.  Northern  Pac.  Ry.  Co.  et  al.,  184  Fed.  80.3. 

^  Consolidated  Gas  Company  vs.  City  of  New  York,  157  Fed.  849. 


104  VALUE  FOR  RATE-MAKING 

mere  theorists  only,  at  the  present  day,  insist  upon  such  as  the  valua- 
tion. Practical  men  know  that  it  is  not  the  test.  There  can  be  no  true 
test,  other  than  the  physical  valuation,  and  to  such  physical  valuation 
there  must  be  added  certain  other  items. 

"This  case  seems  to  have  been  tried  before  the  master,  by  both  parties, 
upon  the  reproduction  theory;  that  is  to  say  what  this  plant  would  cost 
if  it  were  blotted  out  of  existence,  and  the  city,  or  some  other  company, 
were  to  undertake  to  reproduce  the  plant. "^ 

The  most  important  single  piece  of  valuation  work  now  being 
carried  on  is  that  of  the  Interstate  Commerce  Commission  in 
valuing  the  steam  railroads  of  this  country.  The  cost  of  repro- 
duction new  is  being  ascertained,  and  in  reply  to  an  inquiry  sub- 
mitted by  Director  Prouty,  representatives  of  the  railroads  stated 
their  position  as  follows: 

"In  determining  the  cost  of  reproduction  new,  reference  shall  be  had 
to  the  conditions  as  they  exist  at  valuation  date,  but  the  historical 
construction  of  the  property  must  be  taken  into  consideration  whenever 
a  rational  engineering  program  for  reproduction  would  so  warrant  or 
require.  Conditions  existing  on  the  valuation  date  as  to  population, 
business  capacity,  and  productiveness  and  property  values  in  the  terri- 
tory served  by  the  carrier  are  to  be  taken. 

"The  same  quantities  and  classes  of  grading  materials  which  were 
originally  obtained  on  the  right-of-way  will  be  deemed  to  be  obtainable 
in  the  same  places,  and  the  present  cost  of  moving  the  same  will  be 
ascertained.  The  cost  of  acquiring  other  necessary  materials  from  the 
most  available  sources  on  valuation  date  will  be  ascertained."^ 

The  views  of  the  railroads  with  regard  to  the  above  are  further 
explained  by  them  as  follows: 

"The  reproduction  new  cost  figure  thus  required,  represents  the  cost 
of  an  identical  reproduction  of  the  existing  plant  at  the  present  time,  at 
proper  present  prices,  and  under  present  conditions,  the  historical  con- 
struction of  the  property  to  be  taken  into  consideration  in  order  to  aid 
in  the  ascertainment  of  the  items  comprising  the  transportation  plant, 
or  incidental  to  its  production,  quantities  and  the  character  thereof, 
in  the  ascertainment  of  contingencies,  and  in  the  determination  of  an 
appropriate  economical  engineering  program  for  the  reproduction  of 
the  property."^ 

'  Des  Moines  Water  Co.  vs.  Des  Moines,  194  Federal  197. 

^  Brief  filed  on  behalf  of  the  railroad  companies  represented  by  the  Presidents'  Conference 
Committee,  before  the  Interstate  Commerce  Commission,  Sept.  1,  1915,  pages  30  and  39. 


COST  OF  h'l<:/'ROI)('('TfOX  KK- 

The  authorized  representatives  of  public  utility  coiiuiiissions 
of  the  various  states  having  to  do  with  railroad  ijroprrties, 
answered  Commissioner  Prouty's  inquiry  as  follows: 

"As  a  general  principle,  cost  of  reproduction  new  should  \>v  (Icter- 
niined  on  the  basis  of  present  conditions." 

The  cost  of  reproduction  has,  in  very  many  instances,  hoen 
used  in  ascertaining  the  value  of  the  physical  property  only. 
There  is  no  reason  why  the  principle  and  the  method  should  not 
be  used  uniformly  in  ascertaining  the  value  of  the  entire  prop(>rty 
of  any  utility.  In  practically  all  valuation  work  the  cost  of  re- 
production, present-day  prices,  namely,  the  basis  of  a  transac- 
tion between  a  willing  seller  and  a  willing  buyer,  has  been  used 
in  determining  the  values  of  real  estate  and  rights-of-way.  The 
courts  have  uniformly  and  definitely  ruled  that  the  present  value 
of  land  is  the  only  value  to  be  considered  in  determining  the  value 
of  such  property  of  pubUc  utilities.  Consequently,  even  those 
authorities  who  have  adopted  other  bases  than  reproduction  cost 
for  ascertaining  the  value  of  the  remaining  parts  of  the  property, 
have  added  to  such  values  the  present  value  of  real  estate,  in 
order  to  determine  the  total  value. 

It  has  been  a  very  common  practice  in  the  valuation  of  utility 
property  to  use  the  present  cost  of  reproduction  of  physical 
property,  adding  thereto  the  original  cost  of  developing  the  busi- 
ness, in  order  to  ascertain  the  total  value  of  a  given  projKM-ty. 
This  method  was  formerly  allowed  practically  exclusively  by  tlu^ 
Railroad  Commission  of  Wisconsin  and  has  the  weight  of  court 
approval,  as  shown  in  the  following  pages  under  "Going  Value." 
There  is,  however,  no  reason  why  "going  value,"  as  well  as 
other  physical,  non-physical  or  overhead  charges,  should  not  lie 
determined  by  the  consideration  of  present  cost  of  reproduction 
rather  than  historical,  original  cost.  Certainly,  from  the  stand- 
point of  consistency  and  logic,  any  estimate  that  is  made  up  on 
the  basis  of  reproduction  cost  for  the  greater  part  of  the  total 
property,  should  use  the  same  uniform  basis  throughout ;  failure 
to  apply  the  same  standard  of  measurement  to  all  parts  of  the 
property  might  well  seem  to  provide  grounds  for  raising  questions 
as  to  the  legality  of  any  such  hybrid  procedure. 

The  two  methods,  cost  of  reproduction  and  original  cost,  should 
be  kept  separate  and  distinct,  otherwise  great  harm  may  be  done 
either  to  the  public  or  to  the  utility.     There  is  a  tentlency  among 


IOC,  VALUE  FOR  RATE-MAKING 

certain  engineers,  and,  to  a  limited  extent,  in  the  decisions  of 
the  commissioners,  to  confuse  the  two  methods.  Any  such  pro- 
cedure is  an  abandonment  of  the  reproduction  method.  It  is  a 
mixture  of  that  method  with  the  original  cost  method.  The 
fallacy  of  such  procedure  is  primarily  due  to  the  fact  that  its 
supporters  are  trying  to  find  one  sum  or  cost,  which  alone  is  to 
be  considered  the  value  of  the  property.  But  the  courts  have 
decided  that  there  shall  be  ascertained  several  different  costs; 
namely,  reproduction  cost,  original  cost,  reproduction  cost  less 
depreciation,  and  from  a  consideration  of  all  of  these  and  other 
costs,  and  the  exercise  of  a  wise  judgment,  the  fair  value  of  the 
property  is  to  be  determined. 

Under  the  reproduction  method,  to  be  consistent  and  logical, 
the  cost  should  be  figured  or  determined  upon  the  basis  of  exist- 
ing, to-day's  conditions.  Alongside  this  estimate  may  be  placed 
the  actual  original  cost,  if  it  can  be  determined,  and  the  other 
estimates  based  on  the  other  lines  of  pertinent  proof,  as  indicated 
in  the  Smyth  vs.  Ames  case,  but  there  is  no  logical  or  legal  warrant 
for  determining  cost,  as  an  element  of  value,  by  basing  it  partl}^ 
upon  the  reproduction  method  and  partly  upon  the  original 
cost  method  or  basing  it  on  present  prices  applied  to  historic 
conditions. 

Perhaps  the  reason  for  taking  cost  or  historical  values  for 
structural  property  and  reproduction  or  market  value  for  land 
and  combining  such  figures  in  ascertaining  the  total  value  of 
utility  property,  may  be  found  in  the  explanation  made  by  Ex- 
Chairman  Stevens  of  the  Public  Service  Commission  of  New 
York,  Second  District,  where  he  says: 

"The  land  owned  by  the  respondent  consists  of  five  distinct  parcels 
which  are  carried  upon  its  books  at  $54,601.45,  this  being  their  cost. 
This  is  the  sum  at  which  they  are  carried  in  the  examiner's  report. 
Land  has  a  value  for  other  purposes  than  that  of  carrying  on  the  proper 
business  of  the  company.  It  could  be  retired  from  the  service  at  any 
time  at  its  market  value  for  such  other  purposes.  This  fact  differen- 
tiates it  from  the  property  which  is  valuable  only  for  company  operations, 
and  it  has  been  universally  held  that  a  company  is  entitled  to  a  just  and 
reasonable  return  upon  the  present  value  or  market  value  of  tlie  land 
used  by  it  in  the  public  service.  It  is  clearly  distinguishable  in  principle 
from  those  things  which  have  no  value  except  in  the  service  of  the 
company  except  scrap  value."' 

>3  P.  S.  C.  2(i  n.  (X.  V.)  0.50. 


CO^T  OF  REPRODir-TrON  107 

The  Massachusetts  PubUe  Service  Coinmissioii  has  this  I0  say 
with  regard  to  the  reproduction  cost  theory: 

"It  is  a  matter  of  common  knowledge  that  in  Massachusetts  (hiring 
recent  years  this  reproduction  cost  theory  as  a  basis  for  rate-nmkiiin 
has  been  urged  on  behalf  of  certain  public  utility  c()nii):iiiios,  mostly 
gas  companies  that  have  accumulated  out  of  excess  earnings  or  uncarueil 
increment  upon  land  values,  large  amounts  of  property  not  represented 
by  the  original  capital  invested  or  by  the  stocks  and  bonds  issued  under 
our  anti-stockwatering  laws. 

"Undoubtedly  in  rate  cases  and  other  cases  involving  the  conflicting 
rights  of  the  rate-paying  public  and  the  investing  public,  the  cost  of 
reproduction  may  frequently  be  a  fact  desirable  to  be  ascertained,  and 
sometimes  it  illuminates  important  aspects  of  the  problem  presented; 
it  is  often  the  best  method  of  checking  up  unsatisfactory  accounting, 
particularly  when  dealing  with  depreciation.  But  as  a  fundamentally 
controlling  principle,  no  theory  could  work  out  grosser  injustice— 
to  the  rate-paying  public  in  some  cases  and  to  the  investing  public 
in  other  cases — than  the  reproduction  cost  theory.  In  cases  where 
rates  have  for  years  been  too  high,  so  that  the  companies  have  accumu- 
lated, out  of  excess  rates  paid  by  the  public,  large  amounts  which  have 
gone  for  capital  purposes,  this  theory  requires  the  rate-payer  to  pay  a 
rate  adequate  not  only  for  a  return  upon  the  capital  furnished  by  the 
investor  or  stockholder,  but  adequate  also  to  furnishing  capital  and  a 
return  upon  the  capital  furnished;  it  would  authorize  the  capitalization 
of  excessive  rates  and  a  return  upon  that  capitalization.  This  is  to 
put  a  premium  upon  extortions,  past  and  prospective.  On  the  other 
hand,  this  theory  is  grossly  unjust  to  prospective  investors  in  that  even 
when  the  investment  is  made  with  entire  honesty  and  with  reasonable 
prudence,  yet  if,  pending  the  building  up  to  the  new  business,  the 
plant  depreciates  below  the  fair  cost  to  the  investors,  rates  must 
under  this  theory  be  made  adequate  to  make  return  only  upon  the  re- 
production cost  of  the  property  in  its  depreciated  condition.  This 
amounts  to  saying  that  money  lost  during  the  earlier  stages  of  a  publio 
service  enterprise  is  irretrievably  lost  by  the  stockholders;  that  if,  per- 
chance, rates  have  been  fixed  so  low  that  the  rate-payer  has  for  a  period 
of  years  obtained  a  service  at  less  than  cost,  this  is  the  permanent  mis- 
fortune  of  the  stockholders,  and  that  the  public  should  never,  at  any 
time  and  under  any  circumstances,  be  called  upon  to  make  up  a  deficit 
thus  incurred.  On  this  theory  copper  put  into  the  telephone  service  at 
25  cts.  a  pound  is  now  to  be  reckoned  as  worth  about  half  that  sum. 
Every  fluctuation  in  prices  involves  the  ascertainment  of  a  new  rate 
basis.     This  theory  is  as  inexpedient  as  it  is  unjust."^ 

1  Decision  of  the  Massachusetts  Public  Service  Commission,  ApprovinR  an  InoronBO  in 
the  Rates  of  Fare  of  the  Middlesex  and  Boston  Street  Railway  Company,  Oct.  28,  1914. 


108  VALUE  FOR  RATE-MAKING 

Admitting  that  regulation  has  existed  in  the  State  of  Massa- 
chusetts for  a  number  of  years,  it  can  hardly  be  claimed  that 
even  the  Massachusetts  Commission  has  heretofore  been  assur- 
ing investors  that  they  were  to  get  their  investment  back  or 
that  early  losses  would  later  be  made  good.  Certainly  such 
assurances  could  not  have  been  made  to  investors  in  States 
that  have  never  had  utility  regulation  until  within  the  last 
few  years,  consequently  the  investors,  presumably  in  Massachu- 
setts and  certainly  in  other  States,  have  actually  been  making 
their  investments  upon  the  basis  of  standing  the  losses  or  gain- 
ing the  profits,  as  the  case  might  be.  Warrant  for  such  basis 
of  investment  is  found  in  the  rulings  so  frequently  made  by  the 
Supreme  Court,  that  the  present  value  of  the  property  at  any 
given  time  is  the  basis  upon  which  rates  must  be  determined  at 
that  time.  It  may  be  well  enough  for  the  commissions  to  in- 
augurate a  policy  and  give  more  or  less  definite  assurances  as 
to  the  safety  of  investments  and  the  recouping  of  early  losses, 
but  in  so  doing,  the  present  fair  value  of  the  existing  property 
must  be  taken  as  the  starting  point,  not  original  investment 
plus  early  losses.  Certainly  such  assurance  on  the  part  of  the 
public  authorities  would  be  eminently  fair,  usually  legal,  and 
would  undoubtedly  result  in  the  securing  of  capital  at  a  lower 
rate  of  return  than  under  the  conditions  heretofore  existing, 
where  the  investor  had  to  cover  the  loss  or  gain  made  in  his 
investment  by  the  rate  of  return  obtained.  The  Massachusetts 
Commission  is  wrong  in  stating  that  "no  theory  could  work 
out  grosser  injustice"  than  the  reproduction  cost  theory, 
because  that  theory  is  of  fundamental  importance  in  ascertain- 
ing present  fair  value,  which  value  is  the  one  that  both  the  in- 
vesting public  and  the  rate-paying  public  have  been  accustomed 
to  consider  the  fair  and  proper  value  in  determining  rates.  There 
is  no  reason  to  imply  that  "investments  honestly  and  prudently 
made  and  wisely  managed"  may  not  be  as  fully  and  fairly  pro- 
tected by  allowing  a  rate  of  return  sufficiently  high  to  cover  the 
occasional  loss  of  investment  as  to  permit  only  a  lower  rate  of 
return  upon  the  original  investment,  regardless  of  its  present 
value,  with  a  view  to  insuring  each  such  investment.  The 
writer  has  no  quarrel  with  the  principle  that  honest  investments 
should  henceforth  be  protected,  that  a  uniformly  fair  return 
thereon  will  be  assured,  that  early  losses  will  be  made  good,  but 
in  establishing  this  new  regime  ex  post  facto  rulings  must  not 


COST  OF  REPRODUCTION  io<j 

be  attempted  by  the  substitution  of  original  invest niciit  i<n- 
present  fair  value,  which  the  courts  rule  is  the  starting  [joint  for 
consideration  in  determining  the  basis  of  rates. 

In  summation,  it  may  be  said  that  the  cost  of  rcprotluction 
method  should  usually  be  given  the  greatest  of  weight  of  any  of 
the  elements  to  be  considered  in  fixing  the  present  value  of  utility 
property,  because: 

The  reproduction  method  is  universally  applicable. 

The  reproduction  method  gives  the  present-day  value  of  the 
property. 

The  reproduction  method  is  an  eminently  feasil)Ie  and  prac- 
ticable method  of  arriving  at  value. 

The  reproduction  method  has  been  approved  by  the  highest 
courts. 

Reproduction  New. — The  reproduction  theory,  as  originally 
developed,  consists  of  estimating  the  cost  of  reproducing  the 
existing  property  under  present  surrounding  physical  con- 
ditions, with  present-day  prices  of  labor  and  material,  although 
widely  fluctuating  prices  are  usually  averaged.  Thus  it  will  be 
seen  that  the  reproduction  theory  attempts  to  fix  the  value  of 
an  entire  property  as  it  exists  as  a  present  going  business,  in- 
cluding any  unearned  increment  due  to  increase  over  original 
cost  of  real  estate,  labor  or  material,  as  well  as  such  reduction 
in  value  as  results  from  improvements  and  economies  in  con- 
struction methods,  decrement  in  real  estate  or  structural  cost. 
For  example,  a  utility  may  have  originally  spent  a  large  amount 
of  money  excavating  a  trench  with  hand  drills  and  black  powder 
that  to-day  would  be  built  with  modern  machinery  and  high 
explosives,  but  in  ascertaining  the  present-day  value,  the  cost 
of  doing  the  work  with  modern  methods  would  usually  be  ac- 
cepted. On  the  other  hand,  present  cost  of  labor  would  be  ap- 
preciably higher  than  labor  for  any  period  a  few  years  previous, 
and  so  for  most  localities  the  present  value  of  real  estate  would 
be  considerably  higher  than  its  value  a  few  years  ago.  The  ap- 
plication of  this  method  of  utility  valuation  is  merely  applying 
to  such  corporations  the  same  economic  rule  that  is  generally 
applied  to  private  enterprises  in  fixing  their  values. 

A  modification  of  the  above-described,  strict  reproduction 
method  has  been  developed  in  the  attempt  to  keep  down  the 
present  values  of  existing  utility  property.  This  modification  of 
the  pure  reproduction  method  consists  in  estimating  the  cost  of 


no  VALUE  FOR  RATE-MAKING 

reproducing  the  existing  property  on  the  basis  of  current  prices 
for  labor  and  material,  but  differs  by  the  substitution  of  original 
surrounding  conditions  of  land  and  structures  at  the  time  of 
initial  construction,  in  place  of  those  actually  existing  at  the 
time  of  the  valuation.  Thus,  the  utility  gains  by  any  increment 
in  labor  and  material  prices,  but  loses  all  enhancements  of  value 
due  to  rise  in  prices  of  real  estate,  appreciation  in  roadbed, 
adaptation  and  the  like.  The  method  may  exclude  or  take  ad- 
vantage of  modern  methods  of  doing  construction,  as  deter- 
mined by  the  investigator. 

A  still  further  modification  of  the  pure  reproduction  method 
has  been  developed  in  reproducing  the  existing  property  not  as 
a  whole,  in  a  continvious  process  at  one  time,  but  rather  in  the 
manner  in  which  utility  properties  are  usually  constructed,  that 
is,  by  gradual  extension  or  "piecemeal"  or  "retail"  construc- 
tion. This  method,  of  necessity,  results  in  a  higher  valuation 
than  the  wholesale  reproduction  method,  because  small  construc- 
tion jobs  cost  more  per  given  unit  completed  than  large  jobs, 
and  because  continued  accretions  require  tearing  down,  abandon- 
ment or  reconstruction  of  property  that  has  been  temporarily 
completed. 

Still  another  so-called,  but  inappropriately  termed,  reproduc- 
tion method  of  determining  value  has  been  gaining  favor  re- 
cently. The  method  may  be  identified  and  very  much  clarified 
by  coupKng  with  it  the  term  "original  cost."  The  "original- 
cost  reproduction"  method  consists  of  estimating  the  value  of 
the  existing  property  on  the  basis  of  the  prices  paid  for  labor  and 
material  at  the  time  of  the  original  construction  of  the  existing 
property;  said  construction  being  assumed  to  be  done  under 
the  original  physical  and  surrounding  conditions,  at  cost 
usually  determined  from  an  examination  of  the  corporation 
books  and  records.  As  such  method  of  valuation  takes  into 
account  only  the  property  actually  in  existence,  excluding  all 
that  which  may  originally  have  been  installed,  but  of  which 
there  is  no  longer  any  use  being  made,  it  will  be  seen  that  this 
method  in  no  way  corresponds  to  ascertaining  the  original 
total  investment,  or  total  cost  to  date,  referred  to  in  preceding 
pages. 

The  cost  of  reproduction  new,  as  correctly  interpreted  for  use 
in  rate-making,  therefore  means  the  estimated  cost  of  construct- 
ing anew  the  entire  existing  used  and  useful  property,  including 


COST  OF  REP  HOD  LOT  ION  HI 

l)oth  physical  and  non-physical  parts.  It  further  assunu's  the 
estimate  is  based  upon: 

First. — The  use  of  such  prices  as  are  fair  and  average  at  tlie 
time  of  the  appraisal. 

Second. — The  application  of  modern  methods  and  apparatus 
with  intelligent  supervision  and  direction. 

Third. — A  reasonable  and  yet  as  brief  a  period  for  construc- 
tion as  is  practicable  to  avoid  inflating  normal  costs  of  lal)or, 
material  and  financing. 

To  develop  an  estimate  of  the  cost  of  reproduction,  it  is 
customary  to  start  with  the  physical  property,  then  to  add  to 
those  costs  first  found  what  are  loosely  classified  as  "overhead 
items,"  and  afterward  to  include  the  cost  of  establishing  the 
business  and  other  such  non-physical  elements. 

The  cost  of  reproduction  new  of  the  physical  property  in- 
cludes the  fundamental  basic  cost  of  land  and  the  labor  and  ma- 
terial costs  of  structures,  including  engineers'  and  architects'  fees, 
services  of  contractors  w'here  required,  all  kinds  of  insurance, 
and  the  costs  of  administration,  inspection,  testing  and  other 
similar  expenses  incurred  during  construction.  To  these  basic 
figures,  which  result  simply  in  reproducing  new  the  physical 
property,  there  must  be  added  certain  non-physical  or  intangible 
costs  of  two  classes: 

(a)  Those  incurred  in  connection  with  the  preparation  of  the 
physical  property  ready  for  service,  including  the  cost  of  raising 
the  money,  taxes  and  interest  before  and  during  construction, 
expenses  and  services  of  the  promoter,  legal  and  engineering 
advice  preHminary  to  beginning  construction,  expenses  of  secur- 
ing franchises,  permits  or  other  pubHc  authorization,  working 
capital  and  similar  matters. 

(6)  The  cost  of  developing  and  attaching  the  business,  that 
is,  securing  a  revenue.  This  includes  interest  or  a  fair  return 
on  the  value  of  the  property,  the  necessary  allowance  to  cover 
deficits  in  operation  and  similar  items  that  accrue  until  the 
property  is  put  upon  a  paymg  basis. 

The  cost,  preHminary  to  beginning  construction  of  the  physical 
property,  will  ordinarily  run  from  5  per  cent,  to  15  per  cent,  of  the 
cost  of  the  physical  property.  In  the  same  way,  the  overhead 
allowances  to  be  added  to  the  basic  costs  of  the  physical  property 
will  amount  to  12  to  25  per  cent.,  depending  upon  general  market 
conditions,  the  size  and  risk  of  the  enterprise.     The  cost  of  estab- 


112  VALUE  FOR  RATE-MAKING 

lishing  the  business  and  obtaining  a  revenue  sufficient  to  meet 
operating  expenses  and  a  fair  return  upon  tlie  value  of  the 
property  varies  with  the  character  of  the  business  and  to  some 
extent  with  the  size  of  the  corporation  and  the  type  of  the 
community  being  supplied;  it  will  vary  from  10  per  cent,  to  50 
per  cent.,  but  20  per  cent,  of  the  cost  of  the  physical  property 
is  not  an  unusual  figure. 

SUMMARIZED  ELEMENTS  OF  REPRODUCTION  COST 

1.  Land: 

(a)  Real  estate  and  water-rights. 

(b)  Rights-of-way,  easements,  etc. 

2.  Structural  Costs: 

(a)  Physical  property:  construction  and  equipment. 

(b)  Contractor's  services:  including  purchasing  of  materials  and 
equipment,  assembling,  conducting,  superintending  and  executing 
work. 

(c)  Engineering  and  supervision:  including  architect's  fees,  design- 
ing, estimating,  testing  (on  all  construction  and  equipment  items). 

(d)  Administration  and  management:  including  legal  work  on  con- 
struction, rent  and  upkeep  of  offices  and  storerooms,  salaries,  accounting, 
city  inspection,  printing,  stationery  and  other  management  costs  on 
construction. 

(e)  Omissions:  incomplete  inventories,  buried,  submerged,  con- 
cealed or  inaccessible  construction,  loss  and  waste,  incomplete  unit 
prices. 

(/)  Incidentals:  items  too  small  to  inventory,  watchmen,  heating, 
rent  of  land  or  construction  buildings,  duplicate  or  temporary  work. 

ig)  Contingencies:  corrections,  disasters,  delays,  strikes,  idle  labor, 
overtime,  uninsurable  losses,  expressage  on  rush  shipments. 

(h)  Insurance:  fire,  casualty,  builder's  risk. 

(t)  Development  costs,  such  as  unusual,  abnormal  or  extraordinary 
conditions:  changes,  reconstruction,  obstructions,  interferences,  grad- 
ing, extra  cost  of  doing  work  while  maintaining  operation. 

3.  Overhead  Costs: 

(a)  Interest  during  construction. 

(b)  Taxes  during  construction. 

4.  Cost  Preliminary  to  Construction: 

(a)  Preliminary  expenses:  organization,  administration,  engineering, 
legal,  financial, 

(6)  Charter  and  franchise  costs  and  fees:  including  permits,  consents 
and  expenses  of  compliance  with  requirements. 


COST  OF  REPRODUCTION  113 

(c)  Promotion  costs  and  services:  reports,  engineering,  surveys, 
interesting  bankers,  investors  and  local  authorities. 

(d)  Financial  costs:  commissions  to  brokers  and  to  underwriters, 
cost  of  preparing  and  marketing  securities. 

5.  Superseded  Property  Cost  not  yet  Amortized. 

6.  Going  Concern  Cost: 

(a)  Cost  of  reproducing  the  earnings. 

(b)  Cost  of  creating,  developing  and  attaching  business,  advertising, 
soliciting,  concessions,  furnishing  service  or  equipment  free  or  below 
cost,  securing  customers. 

(c)  Costs  of  deficits  in  earnings,  operating  losses  from  strikes,  fuel, 
shortages,  etc.,  legitimate  expenses  to  avoid  uneconomic  competition 
and  to  increase  net  earnings  per  dollar  of  investment. 

7.  Additions  under  Way  or  Necessary  to  Provide  Adequate  Spare  or 
Reserve  Plant  or  to  Properly  Handle  Future  Business. 

8.  Cash  Working  Capital : 

(a)  Cash:  bank  deposits  and  cash  on  hand. 
(6)   Credit  balances. 

(c)  Investments:  (if  necessary  and  not  fully  self-carrying). 

(d)  Reserves:  insurance,  pension,  etc. 

(e)  Deposits:  (if  required  as  surety  by  city,  etc.). 

Construction  Schedule. — In  order  to  make  an  estimate  of  the 
cost  of  reproduction,  it  is  necessary  to  formulate  a  rational 
program  upon  which  it  may  be  assumed  that  a  given  property 
may  be  built  up  along  the  lines  of  a  definite  and  practicable 
schedule.  The  property  to  be  reproduced  is  considered  as  non- 
existent, and  all  steps  necessary  to  produce  the  existing  property 
must  be  assumed  to  be  gone  through  with  in  order  to  obtain  the 
same  results  as  exist  in  the  actual  property  under  consideration. 
The  argument  that  an  estimate  of  the  cost  of  reproduction  is 
based  on  an  instantaneous  recreation  is  illogical  and  misleading. 
Such  conception  originated  in  the  minds  of  theorists  rather  tliaii 
practical  constructionists. 

Inventory. — In  determining  the  value  of  property,  unless 
book  values  are  accepted,  an  inventory  of  the  structural  parts  is 
first  necessary.  As  the  inventory  will  be  the  basis  of  the  entu-e 
valuation,  it  must  be  completed  with  much  detail  and  great 
care  in  order  to  secure  reUable  results.  Within  the  limits  of 
the  time  usually  allowable,  and  having  regard  for  the  expense  of 
the  work  and  the  liability  of  error  on  the  part  of  the  ordinary 
employee,  it  is  practically  impossible  to  make  a  complete  m- 


114  VALUE  FOR  RATE-MAKING 

ventory  of  existing  property.  Experience  shows,  that  even 
with  the  most  thorough  work  and  constant  checking,  the  quan- 
tities hsted  will  be  less  than  the  actual  amounts  existing. 

For  purposes  of  verification  and  in  order  to  comply  with 
court  requirements,  it  is  necessary  to  make  a  detailed  inventory, 
set  up  in  exhaustive  tabulations,  of  the  property  being  appraised. 
This  is  essential,  although  the  labor  and  cost  involved  may  seem 
excessive  and  unwarranted,  but  is  demanded  as  the  one  tangi})le 
element  to  which  all  other  elements  or  estimates  of  the  appraisal 
are  definitely  tied.  The  inventory,  when  priced,  should,  on 
its  face,  clearly  indicate  the  methods,  quantities,  unit  prices, 
with  each  overhead  percentage,  consecutively  leading  up  to 
sub-totals  and  finally  the  grand  total  of  the  completed  appraisal. 

In  the  making  of  an  appraisal,  nothing  is  more  important 
than  a  carefully  prepared,  accurate,  complete,  and  reliable  in- 
ventory. For  suggestions  as  to  the  lines  to  be  followed  for 
convenient  pricing,  the  proper  division  and  classification  of  the 
inventory,  and  other  general  discussions  of  the  subject,  the 
reader  is  referred  to  Chapter  IV  of  the  author's  "Valuation  of 
Public  Utility  Properties." 

Unit  Prices. — For  the  completion  of  the  appraisal,  the  unit 
prices  to  be  used  must  be  carefully  determined.  These  prices 
can  usually  be  fixed  without  much  difficult}^,  if  the  basis  of 
the  prices  is  clearly  understood  and  held  constantly  in  mind. 
The  weight  of  the  best  opinion  at  present  holds  that  the  cost 
of  reproduction  is  based  on  present  prices,  consequently  while 
it  is  necessary  to  examine  bills,  vouchers,  contracts,  minute 
books,  and  other  records  of  the  corporation  to  obtain  information 
as  to  type  and  class  of  property  under  construction,  and  the 
knowledge  of  actual  costs  in  the  past,  such  costs  must  be  recast 
after  an  investigation  of  present  local  conditions,  and  a  con- 
sideration of  present-day  quotations  and  costs,  in  order  to  fix 
present  fair  prices.  As  unit  prices  are  based  upon  facts,  there 
should  be  no  difficulty  in  determining  proper  unit  prices  for 
any  particular  case,  where  the  necessary  amount  of  detailed 
labor  is  performed  in  collecting  the  information  necessary  upon 
which  to  base  conclusions.  There  is,  however,  apt  to  develop 
a  greater  difference  in  the  final  values  of  property  as  determined 
by  different  engineers,  due  to  their  use  of  different  percentage 
allowances  required  to  cover  the  omissions,  incidentals  and 
contingencies  and  other  additions  hereinafter  discussed.     These 


COtiT  OF  RKP  HO  DUCT  ION  115 

differences  arise  from  the  varyiiifr  knowledge  and  experience  of 
the  individuals  determining  the  percentages  applied,  and  such 
differences  may  always  be  expected,  although  not  thereby  pre- 
judicing or  discrediting  the  results,  except  in  so  far  as  the  stand- 
ing or  experience  of  the  party  fixing  such  percentages  may  be 
prejudiced  or  discredited. 

The  making  up  of  unit  prices  in  any  specific  case  will  depend 
upon: 

(a)  The  local  conditions,  as  for  example,  character  of  soil 
in  which  the  excavation  is  to  be  made,  accessibility  for  the 
delivery  of  parts  shipped  in,  conditions  of  the  available  labor 
market  both  as  to  quality  and  supply,  and  similar  local 
characteristics. 

(6)  The  source  and  character  of  the  information  on  which 
the  figures  making  up  the  unit  prices  are  based.  The  informa- 
tion will  vary  from  mere  hearsay  to  exact  figures  obtained  for 
similar  work  under  similar  conditions,  and  the  dependence  to 
be  placed  on  the  source  of  information  must  be  duly  considered 
and  weighed. 

(c)  The  refinement  to  be  used  in  making  up  unit  prices. 
In  some  cases  an  average  figure,  based  on  proper  experience  and 
judgment,  may  prove  as  satisfactory  as  a  figure  laboriously 
worked  out  from  a  mass  of  varying  data.  There  is  always 
opportunity  for  abbreviating  the  work  by  due  consideration  of 
this  matter  by  a  competent  expert. 

(d)  The  relation  of  the  unit  price  to  the  percentages  to  be 
added  later. 

(e)  Whether  or  not  depreciation  is  to  be  allowed  in  the  unit 
price  (not  usually  done). 

(/)  Whether  the  unit  price  applies  to  the  raw  material  or  the 
finished  product.  For  example,  the  purchase  of  a  given  number 
of  yards  of  sand,  concrete  and  stone  results  in  the  production 
of  a  yardage  of  concrete  quite  different  from  the  sum  of  the 
yards  of  the  three  constituents. 

{g)  Whether  the  unit  price  includes  the  cost  of  the  labor, 
material,  supervision,  administration  expense,  and  incidentals 
or  whether  these  items  are  to  be  kept  separate. 

In  order  to  obtain  a  total  fair  value  of  property,  it  is  of  cour.sc 
essential  to  apply  fair  unit  prices  to  the  elements  contained 
in  the  completed  inventory.  Two  unit  prices,  both  fair,  and 
yet  quite  different  in  value,  might  be  used;  one,  the  higher. 


116  VALUE  FOR  RATE-MAKING 

would  include  certain  allowances  which  the  other  would  not 
include,  because  added  later  as  a  percentage  of  the  total  net 
cost.  As  will  be  seen,  the  first  method  endeavors  to  fix  the 
total  cost,  to  the  corporation,  of  the  item  being  considered, 
completely  installed,  including  all  allowances,  but  the  second 
method,  one  which  is  now  much  in  vogue,  endeavors  to  ascertain 
the  exact  price  for  each  item  bought  separately,  then  to  add  to 
the  net  valuation,  obtained  by  applying  such  unit  prices  to  the 
inventory,  definite  percentages  to  cover  first,  an  allowance  that 
would  have  to  be  paid  a  general  contractor  for  doing  the  work  of 
assembling  and  unifying  the  elemental  parts,  and  second,  an 
allowance  to  cover  engineering,  administration  expenses,  con- 
tingencies and  omissions,  etc. 

Fluctuating  Prices. — While  there  is  some  difference  of  opinion 
as  to  whether  unit  prices  of  items,  which  fluctuate  widely  in  cost, 
should  be  based  precisely  upon  those  current  at  the  time  of  the 
appraisal,  or  whether  averaged  prices,  extending  over  a  period 
of  years  should  be  used,  the  more  generally  accepted  method  is 
to  equalize  the  fluctuations  on  the  ground  that  a  constant  rather 
than  a  momentary  valuation  of  utility  property  is  desired. 
In  some  instances,  the  varying  prices  within  a  period  previous 
to  the  date  of  the  appraisal,  have  been  averaged  and  adopted. 
A  common  and  customary  practice  is  to  assume  a  period  of  five 
years,  obtaining  the  average  price  of  labor  and  materials  during 
such  period.  Where  there  is  a  tendency  toward  higher  or 
lower  prices,  such  tendencies  are  sometimes  considered,  when 
the  cost  at  the  time  of  the  inquiry  may  be  adopted  as  more  nearly 
representing  fair  average  conditions.  As  the  purpose  of  valua- 
tion is  to  ascertain  fair  present  value,  fairness  must  be  applied  in 
determining  current  prices.  The  price  of  real  estate  may  have 
been  rising  rapidly  for  a  period  of  years,  and  the  use  of  an 
average  figure  for  the  preceding  five  years  would  be  manifestly 
unfair.  In  the  same  way,  the  uniform  tendency  of  the  cost  of 
lumber  to  rise,  makes  the  present  price  fairer  to  the  recently 
constructed  utility  than  the  average  price.  In  the  same  way, 
the  uniformly  decreasing  cost  of  steam  turbines  or  certain 
electrical  apparatus  might  make  the  use  of  the  average  price 
in  place  of  the  present  price  unfair  to  the  public,  so  that  the 
adoption  of  average  prices  based  on  the  average  of  fluctuating 
prices  over  a  period  of  years,  must  be  used  with  caution  and 
discretion. 


COST  OF  REPRODUCTION  m 

Contractor's  Profit. — Where  unit  prices  have  been  made  up 
upon  the  basis  of  raw  materials  or  apparatus  simply  delivered  at 
their  destination,  and  labor  has  been  put  in  upon  the  basis  of 
wages  paid  workmen,  it  is  quite  customary  to  add  a  certain  per- 
centage to  cover  the  charges  for  a  contractor's  services  and  ex- 
penses. It  is,  of  course,  impossible  to  use  labor  in  putting 
raw  materials  together  without  necessary  supervision,  which  is 
charged  for  under  the  term  "contractor's  profit."  Sometimes 
this  percentage  is  added  to  the  cost  after  applying  unit  prices 
to  the  inventory,  but  quite  often  the  allowance  for  contractor's 
profit  is  added  to  the  unit  price  itself  before  application  to  the 
inventory,  so  that  no  such  percentage  or  allowance  is  apparent 
in  the  final  valuation  tabulation.  This  difference  of  procedure 
has  caused  a  large  amount  of  misunderstanding  and  con- 
troversy as  to  what  is  fair  and  customary,  or  what  allowances 
have  been  made  by  engineers  or  public  authorities  in  fixing  values 
of  property.  It  may  be  said  that  practically  without  exception, 
an  allowance  to  cover  the  contractor's  expenses  and  services 
has  been  included  even  in  what  is  shown  as  the  "bare  bones" 
cost  of  the  structural  property,  in  all  valuations  of  impartial, 
intelligent  public  authorities  that  set  up  no  separate  allowances 
for  "contractor's  profits,"  unless  the  work  is  assumed  to  be  done 
by  Company  forces  and  a  different  unit  price  adopted.  The 
allowance  for  the  contractor  will  vary  from  5  per  cent,  to  15  or 
20  per  cent,  upon  the  cost  of  labor  and  materials  furnished  under 
his  supervision.  In  some  instances  the  percentage  on  labor 
will  be  different  from  that  on  material,  for  example,  10  per  cent, 
on  material  and  15  per  cent,  on  labor  has  been  a  common  allow- 
ance where  contractors  are  working  on  a  "time  and  material 
basis,"  that  is,  where  the  owner  assumes  the  risk,  and  the 
contractor  furnishes  simply  his  services  and  his  own  incidental 
costs.  Where  the  contractor  assumes  the  risk  of  completing  the 
entire  work,  in  large  undertakings  he  will  often  figure  from 
20  to  50  per  cent,  additional  to  the  costs  to  him  of  completing 
the  property,  the  percentage  varying  by  reason  of  the  liability 
to  accident,  definiteness  of  contract,  keenness  of  competition, 
and  other  local  conditions. 

Engineering,  Architects'  Fees,  etc.— It  is  quite  customary,  and 
usually  proper  and  necessary  for  engineers,  architects,  or  other 
qualified  experts,  to  be  employed  to  supervise  and  design  the 
construction  of  any  large  property.     The  charge  for  such  services 


118  VALUE  FOR  RATE-MAKING 

is  ordinarily  based  on  the  cost  of  the  work  supervised;  con- 
sequently it  has  become  an  accepted  rule  in  valuation  work, 
to  add  a  general  percentage  to  the  "general  contractor's  cost," 
or  the  base  cost  "of  the  physical  property,"  to  cover  the  services 
and  expenses  of  the  engineer  or  architect.  Sometimes,  as  is 
done  by  the  Wisconsin  Commission,  a  single  percentage  covering 
engineering,  contingencies,  omissions,  and  other  less  important 
items  is  added,  but  this  is  usually  not  as  satisfactory  or  as 
accurate  as  determining  the  proper  percentage  for  each  of  these 
elements  of  cost,  and  allowing  therefor  separately.  The  reason 
for  this  is  that  the  percentages  are  applicable  to  and  vary  with 
the  different  elements  of  property,  and  an  attempt  to  apply  a 
single  percentage  results  in  confusion  and  controversy.  For 
example,  the  same  percentage  applied  to  the  unit  cost  of  real 
estate,  with  the  purchase  of  which  an  engineer  or  architect  usu- 
ally has  little  to  do,  makes  it  appear  as  if  a  percentage  was  being 
unfairly  allowed  and  added,  necessitating  an  explanation. 
However,  a  proper,  averaged  percentage  can  usually  be  sustained 
on  the  ground  that  while  inapplicable  to  certain  items,  because 
too  high,  yet  it  is  too  low  for  other  items,  and  hence  its  general 
application  to  all  items  results  in  adding  only  the  proper  amount 
in  fixing  the  value  of  the  whole  property.  The  usual  engineer's 
and  architect's  fees  vary  from  5  per  cent,  to  10  per  cent.,  in  some 
instances  running  even  higher.  Five  per  cent,  has  been  quite 
generally  accepted  as  the  proper  engineering  cost,  based  on 
actual  charges  made  by  engineers,  and  upon  records  of  similar 
costs  where  kept  accurately  and  fully. 

Omissions,  Incidentals,  and  Contingencies. — In  order  to 
compensate  for  these  several  items,  it  is  considered  proper,  and 
has  become  generally  customary  to  add  a  small  percentage,  from 
1  to  10  per  cent.,  to  the  sub-totals  in  the  inventory,  after  adding 
unit  prices.  Considering  the  allowances  made  separately  for 
each  class,  that  for  omissions  is  usually  from  2  per  cent,  to  5  per 
cent.,  varying  with  the  thoroughness  with  which  the  work  has 
been  carried  out.  Aside  from  omissions,  there  are  always  a 
large  number  of  small  items  which  cannot  be  included  separately 
in  inventory,  on  account  of  the  labor  and  expense  involved  in 
exactly  ascertaining  what  they  are,  and  listing  them.  These 
small  items  are  usually  called  incidentals,  and  like  omissions, 
are  allowed  for  by  adding  a  small  percentage,  depending  on  the 
minuteness  of  the  inventory,  to  cover  such  items.     The  per- 


CO^T  OF  REPUODVCTIOX  m, 

centage  allowed  for  incidentals  will  vary  from  3^-^  per  cent,  to 
5  or  6  per  cent.,  and  is  usually  taken  at  from  3  to  5  per  cent. 
In  addition  to  omissions  and  incidentals,  the  item  of  conlin- 
gencies  must  be  taken  into  account  in  the  inventory.  Con- 
tingencies are  determined  from  a  consideration  of  the  particular 
property,  and  type  of  construction  under  consideration.  Actual 
quantities  measured  in  place  always  overrun  the  theoretical 
quantities  required,  due  to  loss,  wastage,  shrinkage,  calamities, 
ordinary  human  liability  to  error,  and  the  impossibility  of  con- 
structing property  with  geometrical  exactness.  In  the  con- 
struction of  practically  all  physical  properties,  the  elements  must 
be  taken  into  account,  and  the  losses  they  cause  recognized  and 
allowed  in  the  valuation.  In  building  a  dam,  floods  are  almost 
certain  to  wash  away  material,  and  even  parts  of  completed 
construction;  the  actual  weight  of  cast-iron  pipe  and  metal  work 
must  run  in  excess  of  the  specifications  in  order  to  avoid  pen- 
alties. Earth  work  compacted  in  place  is  much  less  than  the 
yardage  of  loose  material  moved;  necessities  of  construction 
work  require  temporary  structures,  or  the  taking  down  and  re- 
building of  certain  parts.  The  allowances  for  contingencies  may 
be  covered  in  part  by  a  knowledge  of  the  history  of  the  property 
being  considered,  including  records  as  to  conditions  and  costs  of 
construction.  Where  such  knowledge  is  not  obtainable,  experi- 
ence in  similar  work  must  be  the  guide,  but  in  every  case  the 
contingencies  should  be  covered  by  a  percentage  allowance  added 
to  the  value  of  the  inventoried  property,  varying  from  3  per  cent, 
to  much  larger  amounts,  depending  on  the  class  of  propertj-  and 
the  knowledge  of  the  liability  for  contingency  under  the  necessary 
conditions  of  construction. 

Insurance. — The  recent  and  general  agitation  for  the  protection 
of  both  the  public  and  employees  against  accidents,  together  with 
the  many  ''compensation  laws"  being  passed  by  state  legislatures, 
have  resulted  in  making  the  item  of  insurance  a  very  appreciable 
one,  in  comparison  with  the  various  other  expenditures  incurred 
in  completing  a  public  utility  property.  In  many  early  appraisals 
the  cost  of  insurance  was  so  small  as  generally  to  be  included  with 
other  incidentals  in  a  common  percentage,  but  the  man}'-  classes  of 
insurance  now  required,  namely,  that  against  injury  to  the  pul)lic 
and  employees,  damage  from  fire,  flood  and  tornadoes,  guarantees 
for  the  protection  of  property  against  accident,  against  failure  to 
complete  on  time,  and  similar  matters,  have  compelled  recognition 


120  VALUE  FOR  RATE-MAKING 

of  a  separate  allowance  to  cover  specifically  insurance  of  all  kinds. 
The  amount  to  be  allowed  for  insurance  will  depend  upon  the 
location  and  character  of  the  construction  work  undertaken. 
The  risk  of  injury  to  individuals  is,  for  example,  much  greater  in 
the  construction  of  an  underground  electric  trolley  road  in  the 
streets  of  New  York  City  than  in  construction  of  steam  railroads 
across  the  open  country,  and  the  insurance  rate  will  correspond- 
ingly differ.  The  liability  to  damage  from  fire  is,  of  course,  much 
greater  in  a  building  constructed  of  wood  than  one  of  concrete 
and  steel.  In  some  places  tornadoes  are  unknown,  while  in  other 
sections  of  the  country  they  are  relatively  common  occurrences; 
on  some  streams  sudden  and  heavy  floods  are  to  be  expected,  on 
other  streams  they  are  unusual,  so  that  the  proper  amount  to 
allow  for  insurance  in  the  construction  of  any  given  property  is 
determined  from  a  consideration  of  local  conditions  and  the  risks 
involved.  Expressed  in  a  percentage,  the  expenditures  for  insur- 
ance, reasonably  necessary  in  the  construction  of  utility  property, 
will  seldom  be  found  to  be  less  than  one-half  of  1  per  cent,  of  the 
cost  of  the  physical  property,  and  under  extreme  conditions  may 
amount  to  as  much  as  4  or  5  per  cent. 

Development  Costs. — With  regard  to  property  constructed 
under  conditions  other  than  those  which  now  exist,  it  may  be 
necessary  to  include  under  "development  costs"  the  expense 
incurred  in  creating  existing  conditions.  For  example,  in  the 
construction  of  the  underground  trolley  roads  in  New  York 
City,  it  was  necessary  to  remove  from  the  center  to  the  side 
of  the  street  gas  pipes,  water  mains,  and  other  obstructions,  so 
that,  at  present,  the  rights-of-way  on  which  the  tracks  are  laid 
are  free  and  clear.  The  cost  of  reproducing  the  existing  property, 
without  taking  into  account  the  former  obstructions  in  the 
cleared  rights-of-way,  would  not  adequately  represent  the  value 
of  the  existing  property,  and,  therefore,  the  cost  of  clearing  the 
obstructions  must  be  included  as  a  "development  cost."  Simi- 
larly, street  grades  may  have  been  changed,  fillings  made, 
temporary  constructions  installed,  such  as  coffer-dams,  work 
buildings  and  the  like,  or  unusual  conditions  may  exist  which, 
not  apparent  on  first  sight,  nevertheless  require  consideration, 
and  proper  recognition. 

Interest. — The  interest  charges  accumulating  on  capital  ex- 
pended during  the  construction  of  utility  property  properly 
becomes   a  part   of   the  capital   investment.     This  principle  is 


COST  OF  REPRODUCTION  121 

practically   universally  conceded   both   by  public   service  coni- 
missions  and  the  courts: 

"No  case  has  been  cited,  and  in  our  investigation  wc  have  found 
no  case  involving  this  question,  where  a  reasonable  amount  has  not 
been  considered  and  allowed  for  loss  of  interest  during  construction,  as 
a  part  of  the  cost  of  construction."^ 

Opinions  differ  as  to  the  proper  annual  rate  of  interest  to  be 
allowed  but  this  will,  of  course,  vary,  due  to  local  conditions  and 
the  difference  in  the  normal  rate  of  interest  prevailing  in  different 
sections  of  the  country.  The  usual  procedure  is  to  allow  the 
full  interest  rate,  for  half  the  construction  period,  on  the  total 
cost  of  the  property,  or,  what  amounts  to  the  same  thing,  half 
the  interest  rate,  for  the  entire  period  of  construction. 

It  has  been  claimed,  with  justification,  that  the  rate  of  interest 
allowed  should  be  the  same  as  the  rate  of  return  allowed,  on  the 
ground  that  the  investors  should  not  be  limited  merely  to  the 
legal  rate  of  interest  during  the  construction  period  any  more 
than  during  the  remainder  of  the  life  of  their  property.  Another 
important  consideration  in  determining  the  allowance  for  interest, 
is  whether  it  may  be  assumed  that  cash  will  be  advanced  l)y  the 
stockholders  or  bankers,  as  representative  of  the  bondholders,  in 
such  amounts  as  may  be  required  from  month  to  month  to  meet 
construction  accounts  falling  due,  or  whether  practically  the 
whole  amount  of  money  required  for  construction  will  be  paid  in, 
at  or  about  the  time  construction  begins.  In  the  case  of  proper- 
ties costing  relatively  small  amounts,  say  less  than  $500,000,  it  is 
seldom  that  any  particular  advantage  can  be  obtained  by  attempt- 
ing to  distribute  the  payments  of  capital  in  accordance  with  con- 
struction requirements,  and  even  in  the  case  of  very  much  larger 
properties  the  same  still  holds  true.  This  is  well  illustrated  by 
what  has  taken  place  recently,  in  New  York  City,  in  connection 
with  the  securing  of  money  by  the  Brooklyn  Rapid  Transit  Com- 
pany for  the  construction  of  subways.  It  became  necessary  for 
this  company  to  borrow  $40,000,000  with  which  to  carry  out  its 
constructions.  It  did  not  expect  to  be  able  to  expend  more  than 
about  $17,000,000  in  anyone  year;  nevertheless, on  Oct.  1,  1912,  it 
obtained  the  whole  $40,000,000,  having  to  pay  therefor  interest 
at  the  rate  of  6  per  cent.  It  placed  this  money  in  the  bank,  ob- 
taining therefor  3   per  cent,  interest,  and  claimed  the  right  to 

1  Pioneer  Telephone  &  Telegraph  Co.  vs.  Westenhaver,  118  Pac.  354. 


122  VALUE  FOR  RATE-MAKING 

charge  the  difference,  3  per  cent,  on  $40,000,000,  as  part  of  the 
cost  of  plant  construction.  One  of  the  Directors  of  the  Transit 
Company,  in  a  reported  interview,  explained  the  matter  as 
follows : 

"  He  pointed  out  that  the  B.  R.T.  had  acted  according  to  good  business 
policy  in  borrowing  $40,000,000  on  Oct.  1,  last.  He  said  that  the  only 
way  that  the  company  would  be  sure  of  having  the  money  when  it  needed 
it,  even  if  the  need  should  come  several  years  hence,  was  to  borrow  it 
then  altogether  when  the  rates  were  easy.  If  it  were  to  go  into  the 
money  market  now  it  would  have  a  much  harder  time  of  it,  he  said."^ 

Taxes. — Taxes  that  accrue  during  construction  of  utility  prop- 
erty, like  interest,  are  considered  a  part  of  the  capital  invest- 
ment. They  are  sometimes  allowed  as  a  percentage,  charged 
the  same  as  interest,  but  a  fairer  and  more  exact  method  is  to 
base  the  allowance  upon  estimates  made  up  from  a  consideration 
of  the  taxes  actually  being  paid,  itemizing  real  estate  taxes  from 
Federal  or  revenue  and  other  taxes.  The  Public  Service  Com- 
mission of  New  York,  First  District,  in  its  instructions  contained 
in  its  "uniform  system  of  accounts  for  electrical  corporations" 
provides,  on  page  18,  item  E284,  the  following: 

"Charge  to  this  account  all  taxes  and  assessments  levied  and  paid  on 
property  belonging  to  the  corporation  while  under  construction  and  be- 
fore the  plant  is  opened  for  commercial  operation,  except  special  taxes 
assessed  for  street  and  other  improvements,  such  as  grading,  sewering, 
curbing,  guttering,  paving,  sidewalks,  etc.,  which  shall  be  charged  to  the 
account  to  which  the  property  benefited  is  charged." 

Preliminary  Expenses. — Closely  related  to  the  work  of  the 
promoter  are  the  expenses  incurred  in  the  creation,  organization 
and  starting  of  a  utility  corporation.  In  addition  to  the  legal 
work  involved  in  obtaining,  perfecting  and  approving  franchises 
or  consents  of  public  authorities  engineering  estimates  must  be 
checked  and  approved,  financial  prospects  of  revenues  and  earn- 
ings recast  and  certified,  arrangements  for  financing  completed, 
the  formation  of  a  working  organization  instituted  and  general 
plans  completed  for  carrying  out  the  construction  and  operation 
of  the  property  for  which  the  corporation  has  been  originated. 

Preliminary  expenses  will  vary  with  the  type  and  character 
of  the  utility  being  considered,  and  under  normal  conditions 
these  expenses  will  amount  to  from  1^^  to  as  high  as  10  or  15 

i  New   York  Sun,  Dec.  14,  1912. 


COST  OF  REPRODUCTION  123 

per  cent,  of  the  cost  of  those  physical  properties  which  event- 
ually prove  successes.  Of  course,  money  expended  for  prelimi- 
nary work  is  entirely  lost  in  those  corporations  which  nvxi'x 
complete  their  physical  properties,  or  if  completed  prove  to  he 
financial  failures. 

Promotion. — The  services  and  expenses  of  those  engaged  in 
originating  and  getting  a  utility  property  "on  its  feet"  are 
generally  recognized  and  allowed  as  a  part  of  the  capital  cost. 
The  report  of  the  Railroad  Securities  Commission,  consisting  of 
Arthur  T.  Hadley,  Frederick  N.  Judson,  Frederick  Strauss, 
Walter  L.  Fisher  and  B.  H.  Meyer,  to  President  Taft,  at  page  30, 
under  the  head  of  "Promoter's  Profits  and  Services,"  says: 

"We  are  told  that  the  profit  of  the  promoter  represents  a  wholly  un- 
necessary burden  upon  the  American  pubhc,  and  that  so  far  a.s  this 
profit  can  be  done  away  with  it  will  be  good  for  all  parties.  Neither  of 
these  statements  is  quite  true.  The  promoters,  using  the  term  in  a 
broad  sense,  may  be  divided  into  two  classes:  constructors  who  build  a 
road  whose  future  is  uncertain,  in  the  expectation  of  selling  the  stock  for 
more  than  it  costs  them;  and  financiers  who  induce  the  public  to  buy 
the  bonds  of  such  roads.  Both  of  these  classes,  if  they  do  their  work 
honestly,  render  useful  services  to  the  public.  The  constructor  gives  our 
undeveloped  districts  the  benefit  of  new  roads,  which  they  would  not  get 
without  his  intervention;  and  if  he  does  his  business  well  he  builds  the 
road  more  economically  than  anybody  else  could.  The  financier  renders 
an  equally  important  service  in  collecting  the  capital  of  the  investors  to 
build  new  railroads  or  improve  old  ones." 

The  public  service  commissions  have  very  generally  recognized 
the  value  of  the  services  of  the  promoter,  although  some  hold  that 
his  reward  should  be  given  by  allowing  a  larger  rate  of  return 
rather  than  by  a  lump  sum  included  in  the  capital  account.  The 
courts  have  also  recognized  the  legitimacy  of  the  promoter's 
services;  in  one  case  referring  to  such  services  in  effecting  the 
consoHdation  of  numerous  independent  railroad  properties  into 
what  is  now  known  as  the  Southern  Railroad  System,  the  Court 
said : 

"This  enterprise  is  a  perfectly  legitimate  one.  The  men  who  have 
received  and  executed  it  are  entitled  to  a  fair  return  upon  the  money 
which  has  been  actually  invested  in  it.  They  are  entitled,  in  addition, 
to  a  reasonable  profit  upon  the  ability  to  conceive  and  execute  a  project 
of  this  sort."i 

'  City  of  Danville  el  al.  vs.  Southern  Ry.  Co.,  8  I.  C.  C.  U.  409.  438. 


124  VALUE  FOR  RATE-MAKING 

In  contracts  between  municipalities  and  utility  corporations, 
paj^ment  for  the  promoter's  services,  either  in  constructing  the 
property  or  procuring  funds,  has  frequently  been  recognized. 
In  the  existing  contracts  between  the  City  of  Chicago  and  the 
Traction  Companies  there  is  a  clause  which  recites  that  5  per 
cent,  "shall  be  paid  for  the  Company's  services  in  procuring  funds 
therefor,  including  brokerage." 

The  English  courts  have  recognized  the  necessity  for  remuner- 
ating the  promoter,  saying: 

"In  other  words,  we  must  either  refuse  to  follow  the  formula  approved 
by  the  House  of  Lords  and  agreed  to  by  the  parties,  or  find,  as  a  fact, 
that  money  can  be  procured  for  nothing."^ 

The  public  service  commissions  have,  in  some  instances,  used 
5  per  cent,  to  cover  the  expenses  and  services  of  the  promoter. 
In  the  case  of  the  Central  California  Gas  Co.,  the  Railroad  Com- 
mission of  California  allowed  $12,000,  being: 

"$1,000  per  month  for  the  12  months  during  the  organization  period. "^ 

A  more  recent  decision  by  the  same  Commission,  Decision  No. 
1075,  decided  Nov.  11,  1913,  in  the  case  of  the  San  Rafael  & 
San  Anselmo  Valley  Railway  Co.,  page  6,  approves  $2,500  in 
stock,  $1,700  in  bonds  and  $5,000  in  cash,  in  all  $9,200,  to  the 
promoter  of  a  projected  railway  applying  for  issuance  of  stock 
and  bonds  aggregating  $97,379.92,  revised  estimate  of  cost  of  the 
project.  This  would  be  allowing  in  bonds  and  cash  $6,700,  or 
7  per  cent,  of  the  total  cost  of  the  project.  If  we  consider  the 
stock  as  worth  50  cts.  on  the  dollar,  the  total  allowance  for 
promoter's  services  would  be  $7,950,  and  this  is  8  per  cent,  of 
$97,379.  Figuring  stock  at  par  the  fee  amounts  to  nearly  10  per 
cent. 

Financial  Costs. — In  order  to  raise  money  for  any  corporation, 
either  through  the  sale  of  stock  or  bonds,  more  or  less  expense  is 
necessarily  incurred.  From  the  standpoint  of  public  utility 
regulation  it  is  immaterial  from  what  source  the  money  may  come 
which  is  invested  in  property  used  for  serving  the  public.  The 
fair  return  allowed  is  based  upon  the  value  of  the  property.  If 
the  money  necessary  to  create  this  value  may  be  raised  entirely 

'  National  Telephone  Company,  Limited,  vs.  H.  M.  Postmaster,  General  Decision  by 
Judge    Lawrence,     1913. 

^Volume  2,   page  116,  California  Decisions. 


COST  OF  REPRODUCTION  125 

through  the  sale  of  stock  which  in  that  case  will  require  certain 
outlay  in  order  to  dispose  of  the  stock,  or  the  money  may  be  raised 
partly  through  the  sale  of  stock  and  partly  through  the  sale  of 
bonds,  in  which  latter  case  some  of  the  expense  of  marketing  stock 
will  be  saved  as  compared  with  the  condition  of  raising  all  money 
through  the  sale  of  stock,  but  on  the  other  hand  new  expenses  an; 
incurred  in  disposing  of  bonds.  This  latter  expense  is  usually 
brokerage  and  is  paid  to  bond  houses  for  their  services  and  ex- 
penses in  marketing  bonds.  In  either  case  these  financial  ex- 
penses are  a  legitimate  part  of  the  cost  of  creating  the  property 
just  as  much  as  the  charges  for  legal  or  engineering  services,  or 
the  purchase  of  physical  plant.  Naturally  the  cost  of  financing 
will  vary  with  the  character  and  reputation  of  the  utility  being 
considered,  but  will  rarely  be  found  to  be  less  than  2>^  per  cent., 
and  may  amount  to  10  or  15  per  cent,  of  the  face  value  of  the 
securities  sold. 

Overhead  Charges. — The  term  "overhead  charges"  is  fre- 
quently used  in  a  loose  way  to  indicate  all  allowances  of  an  in- 
tangible nature  added  to  the  purely  physical  costs  in  estimating 
the  total  appraisal.  Such  use  of  the  term  may,  but  more  usually 
does  not,  include  the  allowance  for  the  contractor's  or  sub- 
contractor's services  and  expenses.  In  its  broadest  use  it  does 
include  engineering,  omissions,  incidentals,  contingencies,  in- 
surance, interest  and  taxes  during  construction,  costs  of  financing, 
administration  expenses  preliminary  to  and  during  construction, 
as  well  as  for  promoter's  charges,  if  allowed.  Although  not 
usually  so,  overhead  charges  are  sometimes  taken  to  include 
going  value  and  franchise  value. 

The  allowance  of  12  or  15  per  cent,  to  cover  overhead  charges, 
made  by  the  Railroad  Commission  of  Wisconsin,  has  been  made 
the  basis  of  a  similar  percentage  allowance  by  other  commissions 
without  appreciation  of  the  basis  on  which  unit  costs  are  made  up 
by  the  Wisconsin  Commission.  Where  unit  prices  do  not  include 
anything  for  contractor's  profit,  insurance,  administration  ex- 
penses during  construction,  contingencies,  incidentals  and  other 
such  items,  the  addition  of  12  or  15  per  cent,  is  not  usually  suffi- 
cient to  cover  all  proper  overhead  charges.  That  this  is  the  con- 
clusion of  the  Wisconsin  Commission  itself  is  shown  by  such 
statements  as  the  following,  made  in  connection  with  the  testi- 
mony of  two  contractors  who  testified  as  to  the  necessity  for  larger 
overhead  allowances  than  those  made  by  the  Commission: 


126  VALUE  FOR  RATE-MAKING 

"While  their  testimony  throws  some  light  on  the  situation,  their 
figures  apply  to  the  overhead  charges  of  their  own  contracts,  rather  than 
to  the  allowance  which  should  be  added  to  the  estimates  of  the  Commis- 
sion's engineers.  Both  of  these  contractors  have  installed  equipment  for 
the  respondent  company  and  the  figures  used  by  the  staff  include  in  the 
unit  price  the  overhead  referred  to;  for  example,  the  price  used  for  a 
holder  is  the  price  of  the  unit  in  place.  This  price  covers  design,  mate- 
rial, shop  and  installation  labor,  freight,  various  overhead  charges,  and 
profit.  The  overhead  here  included  is  the  overhead  to  which  the  wit- 
nesses referred  and  is  different  from  the  additional  percentage  which 
must  be  added  to  the  cost  of  this  holder  to  cover  the  indirect  expense 
which  the  purchaser  must  incur.  What  has  been  said  in  regard  to  holders 
applies,  to  a  large  extent  at  least,  to  retort  house  equipment,  condensing 
and  purifying  apparatus,  water-gas  machinery,  coal-handling  apparatus, 
etc. ;  in  fact,  to  all  equipment  which  is  customarily  furnished  erected  in 
place  by  the  manufacturer  or  contractor.  In  all  such  cases,  the  prices 
used  by  the  staff  are  intended  to  cover  the  reasonable  value  of  this  equip- 
ment as  erected.  The  testimony  of  these  witnesses,  however,  shows  that 
a  good  deal  of  the  engineering  is  done  by  the  contractor  and  that  on  a 
considerable  portion  of  the  property  under  consideration  the  contractor 
assumes  the  risks  of  installation.  This  would  tend  to  decrease  the  allow- 
ance necessary  for  use  of  tools,  contingencies,  insurance  and  damages, 
omissions,  etc."^ 

From  the  preceding  it  will  be  recognized  that  where  the  Rail- 
road Commission  of  Wisconsin  takes  "the  price  of  the  unit  in 
place,"  which  price  necessarily  includes  all  the  overhead  charges 
added  by  the  contractor  to  his  cost  of  labor  and  material,  and 
adds  to  that  contract  price  12  or  15  per  cent.,  the  Wisconsin  Com- 
mission has  thereby  allowed  somewhere  between  20  and  50  per 
cent,  above  the  unit  price  that  would  be  used,  for  example,  by  the 
Public  Service  Commission  of  New  York  City,  at  least  on  the 
basis  of  costs  used  by  the  latter  during  the  time  that  the  writer 
was  doing  work  for  the  Commission.  This  will  explain  why  some 
commissions,  including  New  York,  basing  their  unit  prices  more 
nearly  on  labor  and  material  costs,  add  larger  percentages  than 
12  or  15  per  cent,  to  cover  the  so-called  overhead  items  of  the 
Wisconsin  Commission. 

The  Public  Service  Commission  of  New  York,  First  District, 
in  the  Queens  Borough  Gas  &  Electric  Company  case,  made  al- 
lowances, to  show  which  the  following  table  is  here  given: 

•  City  of  Milwaukee  vs.  Milwaukee  Gaa  Light  Co.,  12,  W.  R.  C.  R.,  page  445. 


COST  OF  REPRODUCTIOS 


12  < 


T.^BLE    11 

Queens  Borough  case 

Gas  dept. 

Electric  dept. 

Tof.l 

Net  cost  of  property  other  than  land 
C.  P.,  eng.,  admin.,  cont.,  and  inci- 
dentals  

$707,815 

136,345 
19.25 

$637,724 

126,608 
19.85 

$1,345,539 

262,953 
19  55 

Per  cent,  allowed 

It  is  distinctly  stated  in  the  opinion  that  the  above  valuation  of 
$1,345,539  contains  sub-contractor's  profits.  It  is  seen  that, 
in  addition  to  such  sub-contractor's  profits,  there  was  allowed 
in  this  case  for  general  contractor's  profits,  engineering,  adminis- 
tration, contingencies  and  incidentals,  $262,953.  This  is  19.5 
per  cent,  of  the  net  cost  of  the  property,  other  than  land.  But,  in 
addition  to  this,  there  was  allowed,  besides  $75,000  for  working 
capital,  the  sum  of  $220,000  for  ''preliminary  and  development 
expenses."  This  is  16.3  per  cent,  of  the  net  cost  of  the  property 
other  than  land.  Hence,  there  was  allowed  here  for  overhead 
charges,  including  the  contractor's  services  and  expenses,  35.8 
per  cent,  of  the  cost  of  all  of  the  property,  aside  from  land,  before 
it  was  depreciated,  and  this  cost  is  in  addition  to  the  allowance 
for  sub-contractor's  profits.  Had  the  allowances  been  made  upon 
the  depreciated  property  it  would  have  amounted  to  55  per  cent. 
of  such  property,  over  and  above  the  sub-contractor's  fee,  as  is 
seen  by  subtracting  from  $1,345,539  the  sum  of  $468,680,  leaving 
$876,859,  and  of  this  sum  $482,953  is  55  per  cent.  These  allow- 
ances do  not  include  any  allowance  for  going  value. 

In  another  similar  case  of  the  Brooklyn  Borough  Gas  Company, 
the  Commission  allowed  $202,201,  that  is,  24.1  per  cent,  of  the 
net  cost  of  the  property  other  than  land,  "for  general  engineering 
supervision,  administration  expenses,  contingencies,  incidentals 
and  general  contractor's  profit,"  in  addition  to  $180,000,  or 
21.5  percent.,  for  preliminary  and  development  cost.  The  sum  of 
these  two  percentages  is  45.6  per  cent,  added  to  the  cost  of  the 
property  new,  aside  from  land,  for  overheads. 

In  another  case,  in  Kings  County  Lighting  Company,  where  the 
cost  new  of  the  property,  outside  of  land,  was  placed  at  $1 ,56 1 ,628, 
$260,000  or  16.7  per  cent,  was  allowed  for  "  preliminary  and  devel- 
opment expenses,"  and  $341,149  or  20.8  per  cent,  for  contractor's 
profit,  engineering,  etc.,  a  total  of  35.7  per  cent,  for  overheads. 
These  figures  are  shown  in  detail  in  the  following  table: 


128 


VALUE  FOR  RATE-MAKING 


T.\HLK  III. — Comparison  of  Ovkrheads  Allowed  by  New  York 
CoM.MissioN,  First  District 


(Queens  Borough 
(;ii.<  &  F.lec  C-(). 

King.*  County                    Brooklyn 
Lighting  Co.               Borough  Gas  Co. 

Net  cost  of  property  other 

$1,345,539  =  100.0% 

262,953=     19.5% 
220,000  =     16.3% 

$1,561,028  =  100.0% 

341,149  =     21.8% 
260,000  =     16.7% 

$838,154  =100.0% 
202,201  -    24    1  % 

Contractor's   profit,   engi- 
neering, administration, 
contingencies    and    inci- 

Preliniinary   and   develop- 
ment  

180,000  =    21.5% 

(A)   Total 

Working  capital 

$482,953  =     35.8% 
75,000  =       5.6% 

$601,149  =     38.5% 
80,000=       5.1% 

$382,201  =    45.6% 
40,000=      4.8% 

(B)    Total 

$557,953  =     41.4% 

$681,149  =     43.6% 

$422,201  =    50.4% 

A  recent  decision  has  been  rendered  by  the  New  York  Pubhc 
Service  Commission,  First  District,  in  re  Bronx  Gas  &  Electric 
Company,  which  exhaustively  reviews  the  overhead  allowances 
previously  made  by  the  Commission,  and  in  fixing  the  value  of 
the  property  of  the  company  named,  allows  in  said  valuation  2 
per  cent,  of  the  value  of  the  physical  property  for  incomplete 
inventory,  20  per  cent,  on  the  sum  of  the  two  preceding  amounts, 
for  engineering,  supervising,  contractor's  profit,  contingencies 
and  incidentals,  plus  12  per  cent,  for  preliminary  and  develop- 
ment expenses.  The  detailed  figures  of  the  appraisal  are  as 
follows : 

Bronx  Gas  &  Electric  Company 

Total  gas  and  electric  net  reproduction  cost  Per  cent. 

(exclusive  of  real  estate) $785,508 .44  =  100 . 0 

Incomplete  inventory 15,710.17  =     2.0 

Additions  for  other  overheads 160,243.71  =  20.  4 

Preliminary  and  development  expenses ...  .  107,020.68'=    13.6 

Total  overheads $282,974.56  =36.0 

Working  capital   (excess    of  current  assets 

over  liabilities) 45,032.41  =     5.7 

One  of  the  most  important  and  widely  discussed  decisions  of  any 
public  utility  com  mission  is  that  rendered  by  the  Board  of  Utility 
Commissioners  of  New  Jersey  in  the  Passaic  gas  rate  case.  The 
sul)ject  of  overhead  costs  and  going  value  was  thoroughly  con- 
sidered and  fully  disclosed,  and  the  allowances  therefor  have 

'  Based  on  an  allowance  of  12  per  cent,  upon  the  depreciated  value  of  the  physical  property 
plus  the  appraised  value  of  the  real  estate. 


COST  OF  REPRODCCTTOX  120 

been  considered  and  approved  by  the  Supreme  Court  and  tlic 
Court  of  Errors  and  Appeals  of  New  Jersey.  On  the  following 
page  is  given  a  table  summarizing  the  detail  of  findings  an<l 
allowances  made  by  the  Commission.  From  this  talkie  it  will  be 
seen  that  the  allowance  made  for  all  overheads,  including  going 
value,  was  51.45  per  cent,  of  the  net  cost,  to  reproduce  the  plant 
new,  in  addition  to  and  on  top  of  the  allowances  made  for  reward 
to  the  contractor,  covered  in  the  unit  values  adopted  for  the  phy.s- 
ical  property,  before  the  51.45  per  cent,  was  added. 

Table  IV. — General  Summary  of   Commission   Findings 
Passaic,  N.  J. — Public  Service  Gas  Company.     Board  of  Puljlic  Utility 
Commissioners,  N.  J.     Order  Fixing  Rate — Decided  December  26,   1912. 
Land  (at  appraisal  value  plus  10  per  cent,  on 

about  70  per  cent,  of  total  for  "plottage" 

or  "assembly"  value,  i.e.,  7  per  cent,  on 

land  total) $     111,160.00 

Organization;  franchises;  patent  rights;  other 

intangible  gas  capital;  cost  of  establishing 

business;  law  expenses  during  construction.        1,025,000.00 
Manufacturing   plant  X  1.176 

(plus  17.6  per  cent.) =  $1,161,550 

Distribution  system  X  1.176.  .  .  =     2,465,270 

$3,626,820 
Less  3  months'  construction  to 

bring  appraisal  to  7/1/11 62,000 

.$3,564,820 

which  is  made  up  of 
Net  cost  of  structure $3,030,612.00 

and  17.6  per  cent,  thereof  for: 

Per  cent. 

Engineering  and  supervision 5.0 

Omissions 2.0 

Contingencies 2.0 

Organization,  liability,  taxes 2.0 

~iI7o 

Interest  at  6  percent,  on  1.11  per  cent.  6.6 

17.6  534,208.00 

Working  capital 250,000.00 

Total-new .$4,950,980.00 

Accrued  depreciation  deducted 200,980.00 

"Present  Value" $4,750,000.00 

1,025,000+534,208  ^  1,559,2J)8  ^  ^^^^    ^^^  ^^^,  ,„  ,,. 
3,030,612                3,030,612       '^'-       ' 
produce  new. 

(This  51.45  per  cent.,   total  overhead  is  exclusive  of  87.500  alrwuiy  included  for  land 
"plottage.") 
9 


130  VALUE  FOR  RATE-MAKING 

Superseded  Plant. — Probably,  on  a  strictly  reproduction  basis, 
superseded  plant  should  not  be  included  in  the  present  value  of 
existing  property;  certainly  not,  provided  accurate  estimates  of 
the  rate  of  depreciation  had  been  made  and  allowances  for  the 
accumulation  of  necessary  depreciation  reserves  had  been  pro- 
vided in  the  rate  of  return  allowed.  As  a  matter  of  fact,  esti- 
mates as  to  the  rate  of  depreciation  in  the  future  are  at  best 
merely  intelligent  guesses  based  on  the  widest  information  and 
experience  available.  Such  estimates  being  forecasts  of  the 
future  are  necessarily  imperfect,  so  that  even  where  earnings 
might  be  sufficient  to  provide  reserve  funds,  such  funds  may  not 
have  been  accumulated  because  of  erroneous  estimates  as  to  the 
rate  of  depreciation.  In  many  instances  earnings  have  not  been 
sufficient  to  provide  depreciation  reserves  in  large  enough  amounts 
to  take  care  of  rapidly  accruing  depreciation,  so  that  it  has  not 
been  possible  to  write  off  the  superseded  property.  Under  such 
conditions  courts  and  commissions  have  recognized  the  principle 
that  in  fixing  rates,  allowances  should  be  made  in  some  form  for 
the  loss  sustained  because  of  such  superseded  property.  Some- 
times this  loss  may  be  included  in  "going  value, "  particularly 
where  such  item  is  estimated  from  a  consideration  of  the  cost  of 
building  up  the  business.  Where  rates  have  not  been  sufficient 
to  pay  all  fair  operating  charges,  a  fair  return  upon  the  value  of 
the  property  and  take  care  of  depreciation,  the  value  of  super- 
seded property  may  fairly  be  included  in  the  amount  used  as  the 
basis  in  fixing  the  fair  return. 

The  Municipal  Commission  of  Milwaukee,  Wis.,  in  one  im- 
portant case,  where  it  found  the  value  of  the  local  utility  property 
to  amount  to  about  $5,000,000  on  the  basis  of  reproduction  cost, 
excluding  all  value  of  superseded  plant,  the  Court  of  Appeals 
set  aside  the  order  of  the  Commission  on  the  ground  that  at  least 
$2,000,000,  or  40  per  cent,  additional,  should  have  been  included 
as  representing  cost  of  plant  which  had  disappeared  from  the 
present  inventory: 

"I  am  satisfied  that  the  property  of  complainant  represents  a  value, 
based  solely  upon  the  cost  of  reproduction,  exceeding  $5,000,000. 
And  I  am  further  satisfied  that  this  amount  is  not  the  true  measure 
of  the  value  of  the  investment  in  the  enterprise."  ...  "Of  the 
$5,000,000  and  over  paid  for  the  acquisition  of  the  old  fines,  it  would  be 
difficult,  if  not  impossible,  from  the  testimony  to  arrive  at  any  fair 
approximation   of  the  share  or  amount   of  tangible  property   which 


COST  OF  REPRODUCTION  \:u 

enters  into  the  valuation  in  this  inventory.  It  does  appear  that  tlie 
roadways  require  reconstruction  with  new  rails  and  paving,  and  tliat 
the  amount  stated  was  actually  paid  by  the  investors,  making  their 
investment  nearly  $9,000,000.  How  much  of  this  may  be  defined  or 
apportioned  as  the  amount  which  was  both  'really  and  necessarily 
invested  in  the  enterprise'  {vide  Road  Co.  v.  Sandford,  supra),  I  have 
not  attempted  to  ascertain,  except  to  this  extent:  that  I  am  clearly 
of  opinion  that  at  least  $2,000,000  of  these  preliminary  expenditures 
are  entitled  to  equitable  consideration,  as  so  invested,  beyond  the  re- 
production value,  if  the  valuation  of  the  investment  is  not  otherwise 
found  sufficient  for  all  purposes  of  this  case."^ 

"It  is  not  always  reasonable  to  cast  the  entire  burden  of  depreciation 
on  those  who  have  invested  their  money  in  railroads. "^ 

The  principle  enforced  by  the  court  on  the  commission,  in  the 
above  case  is  well  illustrated  in  the  appraisal  of  the  Chicago 
Consolidated  Traction  Company's  property  in  1910,  where  an 
allowance  was  made  for  overhead  charges  of  over  38  per  cent, 
and  in  addition  to  this  they  allowed  several  millions  for  franchise 
value  for  an  old  cable  road  which  was  in  disuse  and  which  was 
immediately  pulled  up  and  thrown  away,  and  on  top  of  those  old 
properties  that  were  out  of  date,  they  capitalized  the  total  cost 
of  the  new  property,  so  that  in  fact  this  Chicago  property  now 
has  perhaps  60  per  cent,  added  to  it. 

The  St.  Louis  Public  Service  Commission,  in  the  case  of  the 
Union  Electric  Light  &  Power  Company,  evidently  included  the 
cost  of  a  certain  amount  of  "superseded  property"  in  its  allow- 
ance for  "established  business,"  for,  after  referring  to  "going 
value"  as  identical  with  the  cost  of  "establishing  the  business," 
the  Commission  adds: 

"The  Commission  is  endeavoring  to  arrive  at  a  fair  value  of  the 
property  at  present  in  the  service  of  the  public  and  does  not  consider 
that  abandoned  property  enters  into  the  calculation  except  so  far  as 
it  effects  the  cost  of  establishing  the  business,  for  which  item  allowance 
has  already  been  made." 

1  Milwaukee  Electric  Railway  &  Light  Co.  vs.  City  of  Milwaukee,  87  Fed.  577,  585. 
^  Ames  vs.  Union  Pac.  Ry.  Co.,  64  Fed.    178. 


CHAPTER  VI 
LAND,  PAVING,  AND  WATER  RIGHTS 

Land  Values. — There  has  recently  developed  considerable 
opposition  to  permitting  utilities  to  have  the  unearned  increment 
arising  from  appreciation  in  land  value.  If  the  investor  were 
guaranteed  under  all  circumstances  a  fair  return  on  his  property, 
there  might  be  some  merit  in  the  argument,  that  he  is  not  entitled 
to  profits  from  the  unearned  increment,  but  such  conditions  do 
not  now,  and  certainly  will  not  obtain  in  this  country,  in  the  near 
future,  consequently  valuations  of  existing  utilities  proposed  to 
be  based  on  such  premises  are  impracticable.  Heretofore  in- 
vestors in  utility  properties  have  been  encouraged  to  believe 
they  would  be  allowed  any  profits  accruing  from,  rise  in  land 
values.  If  investors  are  to  be  allowed  none  of  the  chances  for 
gain  under  advantageous  circumstances,  and  must  stand  those 
losses  accruing  from  disadvantageous  conditions,  the  rate  of 
return  to  be  allowed  must  be  increased,  but  the  higher  courts 
have  never  given  any  intimation  of  recognizing  anything  but 
present  value  in  consideration  of  land  value.  If  the  utility 
investing  in  real  estate  were  not  to  be  allowed  the  unearned 
increment,  the  same  result  would  probably  be  attained  by  some 
circuitous  method,  such  as  ownership  by  individuals  leasing  the 
required  real  estate  to  the  utility  at  regularly  increasing  rates, 
corresponding  to  the  present  value  of  the  land,  so  that,  in  any 
case,  the  public  would  pay  a  fair  return  on  the  present  value  of 
the  land. 

The  question  has  been  raised  that  as  depreciation  of  build- 
ings, for  example,  is  a  charge  against  operation:  why  should  not 
the  appreciation  of  land  be  a  credit? 

The  answer  has  been  well  stated  by  Mr.  C.  P.  Howard: 

"The  funds  provided  for  depreciation  are  a  part  of  the  general 
expense  of  running  the  business — maintenance,  repairs,  and  replace- 
ments. Replacements  are,  in  a  way,  simply  maintenance  and  repairs 
on  a  large  scale,  and  at  longer  intervals.  Depreciation  funds  take  care 
of  replacements.     The  appreciation  of  land  is  entirely  different.     It 

132 


LAND,  PAVING,  AND  WATER  h'fdUrs  \Xi 

has  no  necessary  and  direct  connection  with  operation,  or  with  the  special 
use  made  of  any  particular  piece  of  land.  In  a  general  way,  of  course, 
all  industries  in  the  community  contribute  to  it.  All  other  owners  of 
property  enjoy  this  increase  as  a  clear  bonus;  the  unearned  increment."' 

We  have  never  heard  of  any  other  attempt  than  that  of 
the  Public  Service  Commission  of  New  York,  First  District,  to 
deny,  in  the  face  of  Supreme  Court  decisions,  that  the  increment 
in  the  value  of  real  estate  was  a  part  of  the  utility  capital  upon 
which  returns  must  be  allowed.  In  the  decision  referred  to,  the 
Commission  said: 

"The  present  fair  value  of  the  real  estate  has  been  found  from  the 
evidence  presented  in  this  case.  The  difference  is  the  increase  between 
the  date  of  purchase  and  Dec.  31,  1910.  The  average  annual  increase 
is  found  by  a  simple  mathematical  calculation,  similar  to  that  used  for 
fixing  annual  depreciation.     The  result  is  practically  S35,000."- 

This  average  annual  increase  in  real  estate  value  as  found 
in  the  Kings  County  case  was  treated  as  a  part  of  the  annual 
revenue,  and  made  a  part  of  the  total  revenues  to  be  allowed 
the  company  in  fixing  rates  for  a  fair  return.  This  action  of  the 
Public  Service  Commission  was  appealed  by  the  Kings  County 
Lighting  Company,  first  to  the  Supreme  Court  and  then  to  the 
Court  of  Appeals  of  New  York  State,  the  particular  point  in- 
volved being  certified  to  for  review,  namely: 

"Was  the  Commission  entitled,  upon  the  facts  shown  in  the  record, 
in  ascertaining  the  amount  which  should  constitute  a  proper  return,  to 
consider  as  part  of  what  accrues  to  the  relator  as  gross  receipts  of  its 
yearly  operations,  the  annual  appreciation  in  the  value  of  its  land?" 

Both  of  the  Courts  appealed  to  decided  against  the  Commission, 
holding  in  accordance  with  the  Supreme  Court's  previous  de- 
cisions that  the  present  value  of  real  estate  is  a  part  of  the  prop- 
erty on  which  the  pubhc  must  pay  a  fair  return. 

While,  therefore,  public  regulation  may  in  some  way  prevent 
utilities  from  hereafter  obtaining  the  benefit  of  future  increment 
in  land  values,  up  to  the  present  time  such  increment  belongs  to 
the  owners,  whether  they  are  corporations  or  individuals. 

"There  must  be  a  fair  return  upon  the  reasonable  value  of  the  property 
at  the  time  it  is  being  used  for  the  public."* 

1  Procefduiss  of  the  American  Society  of  Civil  Engineers,  February,  1014,  Vol.  XL.    No.   -. 

page  9387.  ,.  ,    ,,  th- 

2  Reports  of  Public  Service  Commission  of  New  York,  First  District,  \  ol.  II.  paRC  /u.). 
*  Wilcox  vs.  Consolidated  Gas  Company,  212  U.  S.  41. 


134  VALUE  FOR  RATE-MAKING 

"As  to  the  justice  of  the  allowance  of  the  so-called  unearned  in- 
crement there  is  a  wide  divergence  of  opinion.  The  pioneer  goes  out 
into  the  forest,  and  by  his  detriment  of  time,  labor  and  privation  builds  a 
home.  Others  follow,  and  by  joint  efforts  a  community  is  established 
where  once  the  forest  stood.  The  property  of  the  original  settler  has 
now  become  valuable,  and  the  enhanced  value  over  the  actual  cost  and 
expenditure  of  the  settler  we  call  the  'unearned  increment.'  The  term 
'unearned'  is  a  misnomer,  for  the  enhanced  value  has  been  fairly  earned 
by  years  of  labor  and  deprivation.  The  man  who  finally  reaps  the 
harvest  may  not  be  the  same  individual  who  sowed  the  seed.  The 
pioneer  may  not  be  able  to  await  the  day  of  the  harvest,  but  if  he  does, 
no  man  will  say  that  the  harvest  is  not  rightfully  his,  or  that  it  has  not 
been  fairly  earned. 

"So  too  does  the  railway  company  project  its  Hne  into  new  territory 
with  a  full  knowledge  of  the  detriments  to  be  overcome.  The  company 
considers  from  the  beginning  that  no  adequate  return  will  be  made 
during  the  early  years  of  its  history,  but,  like  the  pioneer,  it  helps  to 
build  up  a  new  territory,  with  confidence  that  an  increment  will  result 
sufficient  to  more  than  cover  the  detriment  in  loss  of  returns  or  other- 
wise. The  history  of  our  western  country  more  than  justifies  the  as- 
surance that  such  return  invariably  follows.  We  have  accorded  to  the 
individual  and  to  the  company  the  same  rule  of  measurement,  and  it 
seems  that  in  all  fairness  such  rule  should  be  applied."^ 

It  is  practically  the  unanimous  ruling  of  courts  that  in  de- 
termining the  present  fair  value  real  estate  must  be  taken  at  its 
existing  value,  although  such  value  may  be  less  than  or  many 
times  greater  than  the  original  cost.  This  is  a  consistent  doctrine 
and  is  applied  logically  in  ascertaining  the  value  of  the  property 
at  a  given  time  in  the  service  of  the  public. 

"It  is  insisted  that  in  reproduction  estimates  the  enhanced  value  of 
property  between  the  time  of  the  original  location  of  a  railroad  through 
a  wilderness  or  marsh,  it  may  be,  is  not  to  be  taken  into  account  40  or 
50  years  afterward,  when  civilization,  perhaps  largely  the  result  of  the 
expenditures  and  operations  of  the  road,  has  increased  original  values  a 
hundredfold.  Suppose  a  road  is  located  when  original  cost  is  fabulously 
inflated,  and  the  course  of  events  brings  things  down  to  their  intrinsic 
worth,  upon  whom  does  the  loss  fall?  It  is  usually  understood  that 
the  state  does  not  make  up  such  losses  to  its  citizens.  And,  vice  versa, 
when  minerals  are  discovered  or  oil  wells  developed  on  lands,  does  not 
the  owner  of  the  land  own  its  product?  And  how  are  tax  values  esti- 
mated?    Do  the  officers  take  the  value  when  land  is  first  entered  and 

■  Decision  of  the  Washington  Public  Service  Commission,  Dec.  24,  1914,  fixing  rates  of 
the  Pacific  Northwest  Traction  Co. 


LAND,  PAVING,  AND  WATER  RTCIITS  1.^5 

cleared  or  when  it  has  been  improved  and  becomes  a  town  site?  The  law 
is  perfectly  settled,  with  the  obvious  view  of  the  matter,  that  increments 
and  losses  alike  attach  to  ownership  as  to  duties  and  rights  pertaining 
to  property.  Willcox  vs.  Con.  Gas  Co.,  212  U.  S.  52,  29  Sup.  Ct.  192, 
53  L.  Ed.  382;  Stanislaus  vs.  Irrigation  Co.,  192  U.  S.  215,  24  Sup.  Ct. 
241,  48  L.  Ed.  406;  San  Diego  Land  Co.  vs.  National  City,  174  U.  S.  757, 
19  Sup.  Ct.  804,  43  L.  Ed.  1154.  And  this  just  rule  has  its  balances  and 
adjustments  making  it  not  oppressive  to  the  public  in  any  case.  It  is 
to  be  noticed,  too,  that  the  rates  in  fact  usually  diminish  with  the  in- 
crease in  property  values,  because  the  increase  of  business  dominates 
values  and  justifies  lower  rates;  but,  be  that  as  it  may,  the  rule  of  giving 
to  the  owner  the  increments  of  value  and  subjecting  him  to  the  losses  in 
values  has  the  unequivocal  sanction  of  the  law."^ 

Paving. — In  the  last  two  or  three  years  there  have  been  many 
authoritative  decisions  as  to  the  value  to  be  allowed  for  street 
pavements  in  rate-making.  While  the  drift  of  opinion  seems 
to  be  toward  allowing  the  utility  the  value  of  pavements  neces- 
sarily laid  by  it  in  installing  and  constructing  its  structures 
beneath  street  surfaces,  excluding  the  value  of  all  such  pavements 
as  have  been  laid  at  the  expense  of  the  public  since  the  con- 
struction of  utility  property  in  the  streets,  nevertheless,  the 
question  cannot  yet  be  considered  as  fully  and  finally  settled. 
The  present  difficulties  are  doubtless  largely  due  to  the  failure 
to  appreciate  and  keep  clearly  in  mind  the  difference  and  dis- 
tinction between  cost  and  value.  If  the  fundamental  purpose 
of  the  inquiry  is  to  ascertain  the  actual  investment,  then  only 
the  cost  of  such  paving  as  has  been  laid  by  the  corporation  should 
be  considered;  if,  however,  the  cost  of  reproduction  new  is  being 
ascertained,  then  the  estimated  cost  of  replacing  all  paving  neces- 
sary to  be  laid  in  recreating  the  existing  substrect  structures  must 
be  taken.  Modifications  of  either  of  the  above  methods  may  be 
advisable  or  necessary  in  order  to  determine  facts  upon  which 
to  base  conclusions  as  to  value.  For  example,  it  may  be  de- 
sirable to  ascertain  exactly  how  much  pavement  has  been  put 
down  at  the  expense  of  the  corporation;  in  other  instances,  pav- 
ing over  services  connected  with  gas  or  water  mains  is  sometimes 
paid  for  by  the  consumer,  and  in  such  cases  the  corporation  has  no 
rightful  claim  whatsoever  that  the  value  of  such  pavement  should 
be  included  in  the  value  of  its  property.  It  may  be  assumed 
that  in  every  case  the  pavement  in  the  street  does  not  belong  to 

1  Louisville  &  Nashville  R.  R.  Co..  vs.  Railroad  Commission  of  Alabama.  196  Fed.  821. 


136  VALUE  FOR  RATE-MAKING 

the  corporation,  regardless  of  whether  the  pavement  is  laid  before 
or  after  the  construction  of  the  subsurface  structures,  or  has  been 
paid  for  by  the  corporation  or  the  municipality. 

Although  the  flat-footed  decision  of  the  Supreme  Court  in 
the  Consolidated  Gas  Company  case  still  stands,  wherein  the 
cost  of  reproducing  all  paving,  whether  laid  before  or  after  the 
subsurface  structures  were  installed,  was  allowed  in  the  value 
made  the  basis  of  rates,  nevertheless,  a  more  recent  opinion  of 
the  United  States  Supreme  Court  in  the  Des  Moines  gas  case 
reverses  the  previous  position  of  the  same  court  as  announced 
in  the  Consolidated  Gas  case.  The  Supreme  Court  was  called 
upon  to  decide  an  appeal  from  the  District  Court  for  the 
Southern  District  of  Iowa  to  reverse  a  decree  dismissing  a  bill 
which  sought  to  enjoin  the  enforcement  of  a  municipal  ordinance 
fixing  gas  rates  in  the  City  of  Des  Moines.  Judge  Day,  who 
wrote  the  opinion,  refers  to  the  master's  report  as  giving  "evi- 
dence of  very  thorough  consideration  of  the  subject,"  and  refer- 
ring to  the  exclusion  of  an  item  of  $140,000  by  the  master,  the 
estimated  cost  of  replacing  pavements  laid  after  gas  mains  were 
installed,  says: 

"As  to  the  item  of  $140,000,  which,  it  is  contended,  should  be  added 
to  the  valuation,  because  of  the  fact  that  the  master  valued  the  property 
on  the  basis  of  the  cost  of  reproduction  new,  less  depreciation,  and  it 
would  be  necessary  in  such  reproduction  to  take  up  and  replace  pave- 
ments on  streets  which  were  unpaved  when  the  gas  mains  were  laid,  in 
order  to  replace  the  mains,  we  are  of  the  opinion  that  the  Court  below 
correctly  disposed  of  this  question.  These  pavements  were  already  in 
place.  It  may  be  conceded  that  they  would  require  removal  at  the 
time  when  it  became  necessary  to  reproduce  the  plant  in  this  respect. 
The  master  reached  the  conclusion  that  the  life  of  the  mains  would  not 
be  enhanced  by  the  necessity  of  removing  the  pavements,  and  that  the 
company  had  no  right  of  property  in  the  pavements  thus  dealt  with, 
and  that  there  was  neither  justice  nor  equity  in  requiring  the  people  who 
had  been  at  the  expense  of  paving  the  streets  to  pay  an  additional  sum 
for  gas  because  the  plant,  when  put  in,  would  have  to  be  at  the  expense 
of  taking  up  and  replacing  the  pavements  in  building  the  same.  He 
held  that  such  added  value  was  wholly  theoretical,  when  no  benefit 
was  derived  therefrom.  We  find  no  error  in  this  disposition  of  the 
question."^ 

In  answer  to  the  Court's  objections,  given  above,  there  could 
appropriately  be  quoted  the  very  complete  and  logical  statement 

'  Dos  Moines  Gas  Co.  vs.  City  of  Des  Moines  et  al.,  35  Supreme  Court  Rep.  811. 


LAND,  PAVING,  AND  WATER  RIGHTS  137 

of  the  Federal  Court,  in  the  Louisville  and  Nashville  Railroad 
case,  as  to  why  the  unearned  increment  in  real  estate  is  tlic 
property  of  a  utility.     The  opinion  is  given  on  pages  134  and  135. 

The  California  Commission  has  uniformly  adopted  the  policy 
of  allowing  the  value  of  paving  only  in  case  the  same  has  l)een 
paid  for  by  the  utility  regardless  of  whether  the  case  is  a  rate  or 
purchase  and  sale  case.  The  Indiana,  Arizona,  New  Jersey, 
in  some  instances  New  York,  and  many  other  Public  Service 
Commissions  have  followed  the  same  precedent. 

On  the  other  hand;  a  number  of  state  commissions  have  held 
that  all  paving  over  subsurface  structures  owned  by  public  utiHty 
corporations  should  be  included  in  the  value  of  the  property  of 
the  latter  in  cases  of  purchase,  sale  or  taxes.  In  its  valuation  of 
the  property  of  the  Appleton  Water-works  Company,  the  Rail- 
road Commission  of  Wisconsin  included  the  value  of  pavement 
over  mains,  even  though  it  had  been  laid  without  expense  to  the 
company,  excluding,  however,  the  cost  of  pavement  over  service 
pipes  as  they  had  been  paid  for  by  the  consumers,  although  at  the 
time  of  the  valuation  they  were  owned  by  the  utility.  The 
Supreme  Court  agreed  with  the  Commission  in  refusing  to 
allow  the  value  of  the  paving  over  the  services,  and  in  allowing 
the  value  of  the  paving  over  mains,  saying: 

"Cost  of  reproduction  must  mean  the  cost  which  will  be  necessarily 
incurred  by  a  reasonably  prudent  and  careful  man,  using  ordinary  care- 
ful business  methods,  in  producing  a  plant  of  equal  efficiency.  Anything 
which  under  such  a  conduct  of  the  business  would  cost  nothing  to  repro- 
duce cannot  logically  be  included.  It  is  not  denied  that  if  the  city  or  a 
new  water  company  were  to  establish  a  new  plant  the  consumers  could 
be  required,  as  a  condition  of  receiving  water  service,  to  do  the  work  in 
question,  and  even  furnish  the  pipe;  such  a  requirement  is  quite  generally 
enforced  at  the  present  time  in  cities  of  this  class.  *  *  *  This  is  not 
the  case  where  land  or  other  property  of  value  has  been  voluntarily 
donated  to  the  old  company.  With  regard  to  such  property  it  has  been 
held  in  cases  involving  the  fixing  of  rates  that  it  is  rightfully  to  be  con- 
sidered in  arriving  at  the  cost  of  reproduction.  This  result  is  reached 
on  the  idea  that  a  new  company  could  not  count  on  receiving  such  gifts. 
Whether  the  logic  of  these  cases  be  correct  or  not,  we  do  not  decide, 
but  in  any  event  the  principle  does  not  apply  to  expenses  which  may 
legally  be  assessed,  and  in  the  exercise  of  good  business  judgment  ought 
to  be  assessed,  against  the  consumer.  For  purchase  purposes  at  least 
the  only  expenses  which  could  be  considered  in  the  estimate  of  the  cost 


138  VALUE  FOR  RATE-MAKING 

of  reproduction  are  those  which  are  reasonably  necessary  in  a  prudently 
conducted  reproduction."' 

In  the  Oshkosh  Water-works  Company  case,  the  Wisconsin 
Commission  considered  and  followed  the  rule  which  they  had 
laid  down  in  the  Appleton  case,  which  had  received  the  approval 
of  the  Supreme  Court. 

In  its  opinion  the  Commission  says: 

"It  is  conceded  that  in  reproducing  a  plant  of  efficiency  equal  to  that 
of  the  existing  plant  it  would  be  necessary  to  cut  through  all  paving 
under  which  existing  mains  lie  and  that  the  cost  of  removing  and  relay- 
ing the  paving  would  be  a  part  of  the  construction  cost.  This  principle 
was  recognized  and  applied  by  the  Commission  in  the  Appleton  case 
(m  re  Appleton  W.  W.  Co.,  1910,  6  W.  R.  C.  R.  97,  122)  and  subse- 
quently affirmed  by  the  Supreme  Court  of  this  state  in  the  case  cited 
above.  "^ 

In  a  New  York  tax  case  the  Appellate  Division  held  that  the 
reproduction  cost  of  pavement  laid  with  or  without  expense  to  the 
utility  should  be  included  in  the  value  of  a  special  franchise  under 
the  net  earnings  rule: 

"When  the  pipes  were  laid  in  certain  streets  they  were  unpaved,  and 
afterward  the  city  paved  the  streets.  In  determining  the  reproductive 
cost  of  laying  the  pipes  in  those  streets  the  cost  of  relaying  the  pavement 
was  not  allowed  as  a  part  of  the  reproductive  value.  We  think  it  should 
have  been.  The  fact  that  the  paving  cost  the  company  nothing  is 
immaterial."^ 

In  line  with  the  preceding  decisions,  the  Maryland  State 
Commission  has  very  ably  summarized  the  existing  situation  as 
to  the  valuation  of  pavements. 

"While  it  is  true  that  were  this  company  not  already  in  the  field,  and 
were  it  necessary  for  it  or  some  other  company  to  reproduce  the  property 
as  it  stands,  it  would  be  necessary  to  remove  and  replace  the  paving  of 
the  streets  where  its  mains  and  pipes  have  heretofore  been  laid.  It  is 
to  be  borne  in  mind  that  the  real  effort  of  the  Commission  in  all  inves- 
tigations of  this  character  is  to  ascertain  the  fair  value  of  the  property 
actually  used  in  the  public  service,  and  that  the  cost  of  reproducing 
such  property  is  only  one  of  the  many  elements  to  be  considered  in 
determining  what  is  that  actual  value.     The  reproduction  value  is  not 

>  Appleton  Water-works  Co.  vs.  City  of  Appleton,  142  N.  W.  481. 
^  In  re  purchase,  Oshkosh  Water-works  plant,  12  W.  R.  C.  R.  662. 
3  157  Appellate  Division  165,  142  N.  Y.  Supp.  180,  May  22,  1913. 


LAND,  PAVING,  AND  WATER  RIGHTS  VM) 

in  itself  the  actual  value;  it  simply  reflects  upon  that  value,  just  as  it 
would  reflect  upon  the  market  value,  if  market  value  were  the  inquiry. 

"The  question  as  to  whether  or  not  the  value  of  paving  laid  over  and 
after  the  installation  of  gas  pipes,  water  mains,  or  other  subsurface 
structures  should  be  included  is  a  mooted  one.  In  rate  cases  some 
authorities  have  disallowed  the  value  of  such  pavement  in  fixing  ade- 
quate return  upon  investment  value,  but  as  far  as  we  are  aware,  the 
courts  have  uniformly  held  where  value  has  been  determined  in  purcha.se 
and  sale  cases,  from  a  consideration  of  reproduction  cost,  that  the  value 
of  all  paving  that  would  be  disturbed  by  replacing  the  existing  property 
should  be  included,  regardless  of  the  fact  whether  such  paving  was  laid 
after  or  before  the  subsurface  structures  were  installed.  In  rate  cases, 
therefore,  it  may  be  material  to  separate  the  value  of  paving  into  that 
which  has  been  cut  through  by  the  installation  of  pipes,  mains,  or  other 
structures,  and  that  which  has  been  laid  after  the  installation  of  such 
structures,  but  in  purchase  and  sale  cases,  it  would  seem  that  the  total 
value  of  the  paving  must  be  considered,  because  the  question  to  be 
determined  is  not  investment  value  but  present  value.  It  must  be 
conceded  that  the  purchase  price  of  property  may  be,  and  often  is,  less 
than  the  owner's  investment.  It  may  be,  where  the  facts  warrant,  that 
the  purchase  price  is  much  larger  than  the  owner's  investment.  In 
determining  the  rate  to  be  allowed  the  owner,  it  may,  under  certain 
circumstances,  be  fair  to  fix  the  rate  from  a  consideration  of  the  owner's 
investment,  but  usually  the  question  to  be  determined  is  present  value, 
not  original  value." ^ 

Water  Rights. — In  order  to  determine  the  basis  on  which  to 
predicate  the  value  of  rights  to  or  ownership  in  water,  con- 
sideration should  be  given  the  development  of  existing  laws 
and  priority  of  use  of  water.  The  State  and  National  laws  of 
the  United  States,  which  relate  to  the  control  and  use  of  non- 
navigable  water,  are  far  from  being  generally  satisfactory.  The 
existing  laws  are  the  result  of  conditions  which  have  since  greatly 
changed.  The  fundamental  principle  heretofore  generally  recog- 
nized in  connection  with  non-navigable  water  is  that  the  water 
may  not  be  permanently  diverted  from  its  natural  channel. 
Following  British  practice,  the  American  courts  and  legislatures 
in  the  Eastern  part  of  the  United  States  have  been  accustomed 
to  hold  that  the  natural  flow  of  a  stream  may  not  be  interrupted 
or  diverted  to  the  detriment  of  any  riparian  owner  farther  down 
the  stream,  the  right  to  use  the  water  belonging  to  the  individual 
who  controls  the  banks  of  the  stream.     With  the  development 

•  24  A.  T.  &  T.  Co.  Com.  L.  .564,  Aug.  27.  1913,  Maryland  Public  Service  CommiBsion. 


140  VALUE  FOR  RATE-MAKING 

of  the  country  and  a  growing  public  necessity  for  the  diversion 
of  water  from  its  natural  channel  for  various  purposes,  especially 
for  municipal  and  irrigation  use,  the  old  riparian  law  is  being 
modified  by  the  right  of  appropriation  and  diversion.  The 
latter  principle  has  been  very  generally  accepted  in  the  West, 
where  it  is  frequently  necessary  to  divert  water  from  its  natural 
channels  and  convey  it  to  distant  points  in  order  that  it  may  be 
used  most  beneficially. 

As  conditions  change,  law  and  government  may  be  modified 
to  insure  the  greatest  good  to  the  greatest  number.  Conse- 
quently, the  undue  precedence  given  the  use  of  water  for  naviga- 
tion by  the  national  authorities  is  being  modified  because  largely 
obsolete,  the  most  important  use  of  water  being  in  connection 
with  the  life  and  health  of  humanity.  The  order  of  the  preced- 
ence to  be  recognized  in  granting  the  use  of  water  is  well  set  forth 
in  a  report  of  a  special  committee  of  the  American  Society  of 
Civil  Engineers  "on  a  national  water  law": 

"  (a)  The  first  use  of  water  in  importance  and  the  one  truly  para- 
mount, namely,  that  for  the  domestic  or  household  requirements  of  man 
— one  without  which  life  itself  must  disappear — was  not  recognized  as 
of  sufficient  consequence  for  consideration  when  the  rights  of  naviga- 
tion received  their  present  prominence  in  this  country.  At  the  time  of 
the  adoption  of  the  Federal  Constitution,  outside  of  New  York  City 
and  Bethlehem,  Pa.,  municipal  or  public  water  supplies  appear  to 
have  been  non-existent  in  America. 

(b)  The  second  use  of  water,  in  present  importance,  is  that  for  the 
watering  of  live  stock  and  the  production  of  crops,  upon  which  two 
factors  depend  the  food  supplies  of  the  nation.  The  former  of  these 
applications  is  long  recognized  and  well  established,  but  the  latter,  now 
reaching  its  highest  development  in  the  vast  irrigation  systems  of  the 
arid  and  semi-arid  States,  is  a  use  almost  unknown  in  this  country 
prior  to  the  Civil  War.  Coordinate  with  this  use,  and  as  a  necessary 
adjunct  in  many  cases,  is  the  drainage  of  lands  rendered  unproductive 
by  an  excess  of  water. 

(c)  The  third  in  relative  importance  is  the  use  of  water  in  the  dis- 
posal of  city  sewage,  for,  whether  with  or  without  preliminary  treatment, 
the  sewage  from  inland  cities  must  of  necessity  be  carried  away  and 
finally  disposed  of  in  natural  waterways,  which  are  a  part  of  the  great 
circulatory  system  of  the  country ;  and  the  right  to  the  use  of  water  for 
this  purpose  must  be  clearly  recognized. 

(d)  The  fourth  use  is  that  for  manufacturing,  and  for  the  generation 
of  power  to  be  used  in  the  production  of  the  requisites  of  civilization. 


LAND,  PAVING,  AND  WATER  RICllTS  \ 


II 


The  former  is  practically  inseparable  from  the  domestic  uses  in  an 
ordinary  municipality,  but  the  latter  is  a  larger,  more  specific  and  more 
easily  distinguished  use  and  is  commonly  designated  power  development. 
Closely  related  to  the  above  is  the  preservation  of  property  by  \nu- 
tection  against  floods  and  the  regulation  of  the  stream  flgw  to  this  end, 
as  well  as  with  a  view  to  an  increased  utilization  of  the  water. 

(e)  The  fifth  use  is  that  for  the  transportation  of  the  products  of 
agriculture  and  the  materials  of  manufacture,  and  for  the  convenience 
of  travel,  designated  as  navigation."^ 

Although  many  individual  states  claim  the  right  to  control 
all  waters  within  their  respective  boundaries,  the  Federal  Govern- 
ment has  assumed  the  right  to  limit  and  control  the  use  of  waters 
on  so-called  public  lands  or  in  navigable  streams,  and  in  certain 
instances  has  prohibited  the  use  of  water,  regardless  of  riparian 
ownership,  even  absolutely  preventing  the  extension  and  com- 
pletion of  projected  hydraulic  developments,  for  example,  at 
Niagara  Falls,  New  York. 

Under  the  law  of  appropriation,  regardless  of  previous  land 
grants  or  concessions  or  proprietorship  in  underlying  or  adjoining 
real  estate,  an  individual  or  corporation  may  appropriate  and  use 
for  any  beneficent  purpose  the  unappropriated  waters  of  any 
stream.  This  doctrine  limits  the  right  to  appropriate  unappro- 
priated water  merely  by  the  requirement  that  the  water  shall  be 
actively  and  beneficially  used. 

The  Western  States  particularly  argue  that  as  they  were  ad- 
mitted into  the  Union  upon  an  equal  footing  with  the  other 
states,  they  were  given  absolute  control  of  waters  within  their 
boundaries  and  that,  therefore,  the  Federal  Government  has  no 
right  to  the  control  of  the  waters.  A  study  of  the  decisions  of 
the  courts  seems  to  indicate  that  there  is  no  clear  and  con- 
clusive finding  to  sustain  their  views. 

The  contention  of  the  advocates  of  the  doctrine  that  the  States 
own  and  control  both  the  navigable  and  non-navigable  waters 
within  their  boundaries  is  usually  based  upon  a  line  of  decisions 
of  the  Supreme  Court,  particularly  Pollard  vs.  Hagan,^  where  the 
point  at  issue  was  "whether  Alabama  is  entitled  to  the  shores  of 
navigable  waters,  the  soils  under  them,  within  her  limits,"  the 
land  in  question  being  ''covered  by  the  water  of  the  Mobile  River 
at  common  high  tide."     The  Court  held  that  "the  shores  of 

«  Presented  to  the  Annual  Meeting,  Jan.  19,  1916. 
^  John  Pollard  et  al.  vs.  John  Hagen  et  ah,  3  How.  212. 


142  VALUE  FOR  RATE-MAKING 

navigable  waters  and  the  soils  under  them"  are  reserved  to  the 
States,  whether  one  of  the  original  thirteen  States  or  one  of  those 
later  admitted  to  the  Union.  The  decision  has,  in  fact,  nothing 
whatsoever  to  do  with  water  rights,  but  deals  with  title  to  land. 
Another  case  cited  by  the  adherents  of  State  rights  is  Kansas 
vs.  Colorado,  which  involved  a  controversy  between  two  States 
as  to  the  diversion  and  use  of  water  from  the  Arkansas  River. 
The  Court  in  that  case  stated : 

"That  if  in  the  present  case  the  National  Government  was  asserting, 
as  against  either  Kansas  or  Colorado,  that  the  appropriation  for  the  pur- 
poses of  irrigation  of  the  waters  of  the  Arkansas  was  affecting  the  naviga- 
bility of  the  stream,  it  would  become  our  duty  to  determine  the  truth  of 
the  charge.     But  the  Government  makes  no  such  contention."^ 

From  the  above  it  will  be  seen  that  one  Federal  question  was 
eliminated  from  the  case  and  with  regard  to  another,  namely, 
the  authority  of  Congress  to  provide  for  the  irrigation  of  arid 
lands,  the  Court  said,  discussing  Section  3  of  Article  IV  of  the 
Constitution : 

"But  clearly  it  does  not  grant  to  Congress  any  legislative  control  over 
the  States  and  must,  so  far  as  they  are  concerned,  be  limited  to  authority 
over  the  property  belonging  to  the  United  States  within  their  limits."^ 

The  Court  does  not  seem  to  hold,  in  the  above  case,  that 
water  was  not  the  property  of  the  United  States.  That  con- 
tention was  not  made,  and  the  decision  of  the  Court  upon  the 
issue  raised  between  the  two  States  mentioned  was: 

"It  is  enough  for  the  purposes  of  this  case  that  each  State  has  full 
jurisdiction  over  the  lands  within  its  borders,  including  the  beds  of 
streams  and  other  waters."' 

In  Jennison  vs.  Kirk^  the  Supreme  Court  rendered  a  decision 
construing  a  Federal  statute.  Revised  Statutes  2339,  which 
expressly  recognized  or  vaHdated  rights  to  the  use  of  waters  for 
mining,  agricultural  and  certain  other  purposes  in  those  cases 
where  the  vested  rights  were  recognized  and  acknowledged  by 
local  customs,  laws  and  decisions  of  the  courts. 

Another  decision,  Broder  vs.  Water  Company,^  is  to  the 
same  effect  as  the  preceding,  and  neither  in  the  statute  mentioned 
nor  in  the  decision  is  there  any  grant  or  admission  by  the  Court 

•  Kansas  vs.  Colorado,  206  U.  S.  46. 
-  98  U.  S.,  453. 
3  101   U.  S.  274. 


LAND,  PAVING,  AND  WATEIi  RICIITS  l  |;{ 

that  the  States  own  or  control  the  waters  witliin  the  puhhc  hinds 
or  reservations.  The  statute  referred  to  seems  to  be  in  the 
nature  of  a  vaUdation  of  possessory  rights  initiated  in  trespass 
or  at  least  without  specific  authority,  for  if  it  was  a  recognition 
of  the  fact  that  the  States  control  the  water,  why  was  the  enacl- 
ment  of  a  Federal  statute  necessary?  Examination  of  the 
enabling  acts  or  grants  to  the  various  States  does  not  seem  either 
in  specific  language  or  in  any  other  way,  unless  by  implication, 
to  convey  the  waters  to  the  States,  and  if  title  thereto  be  in  the 
Federal  Government,  and  not  conveyed  l)y  such  acts,  the  title 
to  the  waters  and  the  control  thereof  are  still  the  property  of 
the  United  States  the  same  as  are  the  areas  of  public  land  within 
the  same  States. 

In  Light  vs.  United  States,  speaking  of  govcrnmciit-owncd 
lands,  the  Supreme  Court  said: 

"  'The  Government  has  with  respect  to  its  own  lands  the  rights  of  an 
ordinary  proprietor  to  maintain  its  possession  and  prosecute  trespass- 
ers. It  may  deal  with  such  lands  precisely  as  an  ordinary  individual 
may  deal  with  his  farming  property.  It  may  sell  or  withhold  them  from 
sale.'  Camfield  vs.  United  States,  167  U.  S.  524.  .  .  .  the  Consti- 
tution declares,  §3,  Article  IV,  that  Congress  shall  have  power  to 
dispose  of  and  make  all  needful  rules  and  regulations  respecting  the 
territory  or  the  property  belonging  to  the  United  States.  The  full 
scope  of  this  paragraph  has  never  been  definitely  settled.  Primarily, 
at  least,  it  is  a  grant  of  power  to  the  United  States  of  control  over  its 
property."  1 

In  the  case  of  Winter  vs.  United  States,  certain  white  citizens 
of  the  State  of  Montana  had  appropriated  under  State  laws  and 
were  undertaking  to  use  water  of  Milk  River.  The  United 
States  enjoined  such  use  on  the  ground  that  under  an  agreement 
the  water  was  reserved  for  the  use  and  benefit  of  the  Indians 
of  the  Fort  Belknap  Reservation,  and  that  being  so  reserved  the 
water  could  never  become  subject  to  appropriation  under  State 
laws.     The  Court  in  this  case  said : 

"The  power  of  the  Government  to  reserve  the  waters  and  exempt  them 
from  appropriation  under  the  State  laws  is  not  denied  and  cannot  he."* 

A  similar  ruling  was  made,  in  respect  to  water  reservetl  for  the 
Black  Feet  Indians,  in  Conrad  Investment  Company  vs.  United 

>  220  U.  S.  523. 
^  207  U.  S.  564. 


144  VALUE  FOR  RATE-MAKING 

States.^  It  should  be  pointed  out  that  at  the  time  of  the  agree- 
ment with  the  Indians,  the  country  involved  was  a  territory 
and  had  not  yet  been  created  into  a  State  and  admitted  into  the 
Union,  but  it  may  be  questioned  whether  the  change  from  terri- 
tory to  State  would  alter  the  Court's  ruling. 

The  general  policy  of  Congress  and  the  United  States,  with 
respect  to  the  national  parks  or  other  similar  reservations,  is  well 
known  and  recognized.  In  several  instances,  at  least,  the  States 
have  conceded  or  disclaimed  civil  and  criminal  jurisdiction  within 
reserved  limits,  and  recognized  the  Government's  control  of 
certain  lands,  timber,  objects  of  interest,  etc.  The  right  of  a 
State,  if  it  had  one,  to  waters  on  Government  land  or  within 
reservations  would  be  artificial  and  ineffective,  because  the  State 
has  no  right  to  enter  upon  such  Government-owned  land  adjoin- 
ing the  stream,  or  to  divert  water  from  the  riparian  owner. 

Without  referring  to  other  cases  that  might  be  cited,  in  Gibson 
vs.  Chouteau,  with  regard  to  the  public  domain,  the  Supreme 
Court  said : 

"No  State  Legislature  can  interfere  with  this  right  or  embarrass  its 
exercise."- 

In  a  more  recent  case,  where  a  public  utility  corporation 
claimed  the  right  to  appropriate  and  use  waters  of  a  stream  on 
Government-owned  land  for  hydro-electric  development  without 
first  obtaining  permission  from  the  United  States  Government, 
the  Circuit  Court  of  Appeals,  Eighth  Circuit,  sustained  the  con- 
tention of  the  Government  that  such  action  was  trespass  and 
unauthorized,  saying: 

"The  proposition  that  absolute  and  perpetual  rights  in  the  public 
lands  may  be  acquired  for  private  gain  by  a  mere  appropriation  without 
purchase  or  compensation  and  in  the  exercise  of  a  State  sovereignty, 
which  transcends  the  constitutional  power  of  the  Congress,  is  a  some- 
what startling  one."^ 

This  case  is  now  pending  before  the  United  States  Supreme 
Court  on  appeal.  It  is  hoped  that  the  Court's  finding  in  this 
case  may  definitely  and  finally  settle  all  controversies  as  to  ques- 
tions of  the  State's  ownership  and  control  of  water  within  its 
boundary. 

'  161  Federal  829. 

*  80  U.  S.  92.  • 

«  United  States  vs.  Utah  Power  &  Light  Co. 


LAND,  PAVING,  AND  WATER  RIGHTS  145 

The  right  of  a  State  to  control  the  waters  within  its  boundaries 
does  not  extend  to  water  on  Government-owned  land  unless  Con- 
gress has  conferred  such  right  upon  the  State.  In  fact,  t  he  right  of 
the  State  to  control  waters  within  its  boundaries  rests  upon  the  same 
principles  and  goes  only  as  far  as  the  right  of  any  other  private 
or  pubHc  riparian  proprietor.  Although  nearly  all  the  Western 
States  are  unanimous  in  asserting  the  exclusive  control  l)y  the 
State  authorities  of  all  waters  within  their  boundaries,  and  al- 
though the  State  of  California  has  perhaps  gone  as  far,  if  not 
farther,  than  any  of  the  other  Western  States  in  these  claims, 
nevertheless,  the  Superior  Court  of  that  State  has  itself  very 
definitely  and  convincingly  held  that  the  State's  rights  to  th(! 
waters  are  no  more  nor  no  less  than  the  State  has  through 
ownership  of  riparian  lands. 

"The  theory  that  the  water  of  a  non-navigable  stream  in  this  State  is 
in  some  sense  'public  water'  has  been  advanced  before.  It  has  been 
claimed  that  a  diversion  of  water  under  the  provisions  of  the  Civil  Code 
(Sees.  1410  to  1422)  constitutes  a  grant  of  the  water  by  the  State  to  the 
appropriator.  The  idea  may  have  arisen  from  the  statement  sometimes 
made  in  the  decisions  that  the  riparian  owner  has  no  right  in  the  corpus 
of  the  water  (Eddy  vs.  Simpson,  3  Cal.  252),  and  that  running  water 
cannot  be  made  the  subject  of  private  ownership,  that  the  right  to  use 
the  water  of  a  stream  'carries  no  specific  property  in  the  water  itself 
(Kidd  vs.  Laird,  15  Cal.  179).  This  is  far  from  saying  that  the  property 
in  the  water  is  vested  in  the  public,  either  for  general  use  or  as  property 
of  the  State.  The  doctrine  that  it  is  public  water,  or  that  it  belongs  to 
the  State  because  it  is  not  capable  of  private  ownership,  has  no  support 
in  the  statutes  of  the  State  or  in  any  decision  of  this  court. 

"The  true  reason  for  the  rule  that  there  can  be  no  property  in  the  corpus 
of  the  water  running  in  a  stream  is  not  that  it  is  dedicated  to  the  public, 
but  because  of  the  fact  that  so  long  as  it  continues  to  run  there  cannot  be 
that  possession  of  it  which  is  essential  to  ownership.  It  is  in  this  respect 
similar  to  the  air,  which  cannot  be  said  to  be  possessed  or  owned  by  any 
person  unless  it  is  confined  within  impervious  walls.  One  may  have  the 
right  to  take  water  from  the  stream,  even  the  exclusive  right  to  do  so, 
but  in  that  case  he  does  not  have  the  right  to  a  specific  particle  of  water 
until  he  has  taken  it  from  the  stream  and  reduced  it  to  possession. 
It  then  ceases  to  be  a  part  of  the  stream.  Such  right  to  the  water  of 
running  streams  as  there  is  under  the  law  is  vested  entirely  in  the  several 
riparian  owners  along  its  course.  It  is  subject  to  the  common  use  of  all 
riparian  owners,  but  neither  has  a  specific  property  in  any  part  of  the 
water  while  it  remains  running  in  the  stream.  The  United  States,  with 
respect  to  the  lands  which  it  owns  in  the  State,  is  a  riparian  pro- 

10 


146  VALUE  FOR  RATE-MAKING 

prietor  as  to  the  streams  running  through  such  lands.  It  is  only  by- 
virtue  of  that  fact  that  it  has  any  right  or  power  of  disposition  over 
the  waters  thereof.  And  its  right  and  power  in  that  respect  is  no 
greater  and  no  less  than  that  of  any  other  riparian  proprietor.  By 
the  act  of  July  26,  1866  (14  U.  S.  Stats.  251),  the  United  States 
consented  that  private  persons  might  acquire  rights  to  water  flowing 
in  streams  through  its  lands  by  taking  possession  thereof,  that  is, 
by  diverting  the  same  in  such  manner  as  should  be  provided  by  the 
laws  of  the  particular  State.  Where  such  diversion  had  not  been  made, 
a  grant  of  its  lands  bj'  the  United  States  to  a  private  person  without 
reservation  would  carry  with  it  the  riparian  rights  pertaining  to  that 
land  in  streams  flowing  through  it,  in  the  same  manner  as  in  the  case  of  a 
grant  of  land  by  a  private  owner.  So,  also,  the  State,  with  respect  to 
the  lands  it  owns  which  are  not  devoted  to  a  specific  public  use,  is  in  the 
same  category  as  any  other  land  owner.  It  has  riparian  rights  with 
respect  to  such  land  in  the  streams  running  over  it,  which  its  grant  carries 
to  the  grantee.  The  provisions  of  the  Civil  Code  above  mentioned  have 
the  effect  of  a  declaration  by  the  State  that  any  person  who  may  divert 
water  from  a  stream  in  pursuance  of  those  provisions  will  thereby  ob- 
tain a  right  in  the  stream  paramount  to  the  riparian  rights  which  the 
State  may  have  therein  by  virtue  of  the  fact  that  the  stream  may  run 
over  lands  then  belonging  to  the  State.  To  that  extent  it  operates  as  a 
grant  from  the  State,  but  this  is  only  because  the  State  had  the  riparian 
right,  and  not  because  the  water  was  in  any  sense  public  water  devoted 
to  public  use."^ 

In  determining  the  value  of  water  rights  there  must  be  had  a 
clear  conception  of  what  the  owner  of  such  rights  is  entitled  to. 
The  Supreme  Court  of  the  State  of  California  has  rendered  an 
interesting  decision  indicating  the  limits  to  which  water  rights 
may  extend  even  in  the  Western  States.  The  case  hinged  on  the 
right  of  the  defendant  to  divert  so-called  freshets  or  flood  flows 
of  the  Fresno  River.  The  plaintiff  owned  riparian  land  and  con- 
tended that  it  was  entitled  to  all  the  rights  pertaining  to  riparian 
ownership,  that  the  freshet  or  flood  flows  occurred  in  almost  every 
season  of  normal  rainfall  and  therefore  could  not  be  diverted  by 
the  defendant.     The  Court  spoke  as  follows: 

"It  is  suggested  that  a  different  rule  should  apply  in  a  semi-arid  cli- 
mate like  that  of  California,  where  the  fall  of  rain  and  snow  occurs  during 
only  a  limited  period  of  the  year  and,  consequently,  streams  carry  in  some 
months  a  flow  of  water  greatly  exceeding  that  flowing  during  the  dry 
season,  with  the  result  that  such  increased  flow  is  not,  at  all  points,  con- 

'  Palmer  et  al.  vs.  Railroad  CommisBion  of  the  State  of  California 'et  al,  S.  F.  No.  6555, 
page  201. 


LAND,  PAVING,  AND  WATER  lUailTS  i  17 

fined  within  the  banks  which  mark  the  Umits  of  the  stream  at  low  water. 
But  no  authority  has  been  cited,  and  we  see  no  sufficient  ground  iti 
principle,  for  holding  that  the  rights  of  riparian  proprietors  should  be 
limited  to  the  body  of  water  which  flows  in  the  stream  at  the  period  of 
greatest  scarcity.  What  the  riparian  proprietor  is  entitled  to  as  against 
non-riparian  takers  is  the  ordinary  and  usual  flow  of  the  stream.  There 
is  no  good  reason  for  saying  that  the  greatly  increased  flow  following  the 
annually  recurring  fall  of  rain  and  melting  of  snow  in  the  region  about  the 
head  of  the  stream  is  any  less  usual  or  ordinary  than  the  much  di- 
minished flow  which  comes  after  the  rains  and  the  melted  snows  have 
run  ofT.  Perhaps  other  considerations  should  apply  where  a  river,  in 
times  of  heavy  flow,  runs  over  its  banks  in  such  manner  that  large  vol- 
umes of  water  leave  the  stream  and  spread  over  adjoining  lands  to  an 
indefinite  extent,  there  to  stagnate  until  they  evaporate  or  are  absorl)od 
by  the  soil.  But  the  evidence  of  respondent,  and  this  was  the  evidence 
on  which  the  court  below  acted,  fails  to  show  that  the  water  which  de- 
fendant seeks  to  divert  was  such  'vagrant  water.'  The  evidence  of 
respondent  was  to  the  effect  that  at  all  seasons  the  water  of  the  Fresno 
River,  even  though  overflowing  the  banks  of  the  channel  in  wliich  it  flowed 
during  the  dry  season,  formed  a  single  and  continuously  flowing  stream."' 

The  State  regulating  commissions  have  often  failed  to  recognize 
and  allow  any  value  for  water  rights,  as  such,  in  addition  to  the 
values  of  other  intangible  elements  or  the  physical  property 
itself.  This  attitude  is  shown  in  the  decision  of  the  Public 
Service  Commission  of  New  York,  Second  District,  decided  in 
the  matter  of  rates  of  the  Cataract  Power  &  Conduit  Company: 

"Such  results  as  these  will  never  satisfy  the  elementary  sense  of  right 
and  justice  in  the  mind  of  any  man  with  regard  to  the  use  of  Niagara 
generated  electric  energy.  No  generating  company  using  the  water  of 
Niagara  River  owns  those  waters  or  has  any  right  or  title  to  them  what- 
soever. By  the  permission  of  the  Federal  Government  and  of  the  State 
of  New  York,  the  generating  companies  operating  at  the  Falls  are  given 
the  free  use  of  those  waters  in  the  production  of  electric  energy.  To  say 
that  by  having  been  given  the  free  use  of  those  waters  for  that  purpose 
they  are  vested  with  an  unassailable  right  to  charge  as  much  for  the 
electric  energy  developed  as  they  would  for  energy  developed  by  steam 
plant  is  a  proposition  which  requires  to  be  maintained  rather  than  to 
be  refuted.  It  may  very  well  be  that  these  companies  are  entitled,  m 
view  of  all  of  the  circumstances  of  the  case,  to  a  liberal  return  upon  the 
capital  actually  invested  in  developing  the  energy.  It  may  very  well  be 
that  the  people  exploiting  the  enterprise  are  entitled  to  large,  and  even 

.  Miller  &  Lux  vs.  Madera  Canal  &  Irrigation  Co..  XXXVII.  California  Decisions  No. 
1900,  page  115. 


148  VALUE  FOR  RATE-MAKING 

very  large,  profits  for  the  skill  they  have  displayed  and  the  risk  to  which 
they  have  subjected  their  capital.  It  may  be  that  the  pubhc  ought  to 
pay  them  very  liberally  for  the  work  which  they  have  carried  on  in  the 
public  interest;  but  to  say  that  the  public  is  entitled  to  no  advantage 
from  the  use  of  these  waters,  that  the  territory  which  can  be  served  with 
electric  energy  developed  at  Niagara  Falls  has  no  advantage  and  is 
entitled  to  no  benefit  by  reason  of  proximity  to  those  Falls,  is  to  say 
something  which  does  not  appeal  to  the  best  judgment  of  mankind  for 
an  instant."^ 

It  may  be  noted  that  the  Commission  after  writing  the  above 
as  to  "a  liberal  return  upon  the  capital  actually  invested"  held 
that  the  rates  should  be  reduced  so  that  the  fair  return  was 
"approximately  6  per  cent."  upon  the  "capital  invested  in  the 
public  service."  It  is  only  fair  to  state  in  passing  that  the 
company  did  not  claim  "the  public  is  entitled  to  no  advantage 
from  the  use"  of  water-power-produced  as  against  steam-pro- 
duced, electric  energy  but  rather  it  proposed  to  divide  its  profit 
equally  between  the  public  and  itself. 

There  has  existed  a  tendency  to  regard  water  right  values  as 
analogous  to  franchise  values  and  without  value. 

"What  has  been  heretofore  said  concerning  the  inclusion  of  other  in- 
tangible value,  such  as  'going  concern,'  'good  will'  and  'franchise 
value'  would  apply  to  the  inclusion  of  what  is  termed  'unearned 
increment  value,'  accruing  by  reason  of  the  right  to  the  use  of  water  for 
the  purposes  to  which  it  has  been  dedicated.  We  find,  from  a  careful 
examination  of  the  authorities  cited,  and  these  examined  in  our  own  re- 
search, that  the  courts  and  public  utilities  commission  refuse  to  allow  a 
valuation  of  this  character  other  than  the  actual  cost  thereof  for  the  pur- 
pose of  fixing  rates. "2 

In  the  case  where  a  corporation  acquires  no  proprietary  interest 
but  merely  has  a  franchise  to  appropriate  water  for  diversion, 
transportation  and  sale,  it  may  be  conceded  the  right  of  diversion 
is  merely  equivalent  to  a  franchise  right  but  that  is  distinct  and 
different  from  value  in  the  ownership  of  water  rights. 

"There  is  a  striking  analogy  between  the  appropriation  of  water  for 
beneficial  purposes  and  the  location  of  a  mining  claim.  Neither  the 
appropriation  nor  the  location  gives  to  the  party  claiming  thereunder 

'  Decision  of  Public  Service  Commission  of  New  York,  Second  District,  in  re  Fuhrman 
vs.  Cataract  Power  &  Conduit  Company,  decided  Apr.  2,  1913. 

^  Decision  of  Public  Utilities  Commission  of  Idaho,  Apr.  13,  19M,  in  re  application  of 
Pocatello  Water  Co. 


LAND,  PAVING,  AND  WATER  RK.'flTS  i  lii 

the  absolute  ownership  in  fee.  Under  the  appropriation  laws  lawful 
possession  of  the  water  is  dependent  upon  its  being  used  for  some  bene- 
ficial purpose.  Under  the  mining  location  laws  the  {xjssession  f)f  the 
mining  claim  is  dependent  upon  the  performance  of  a  certain  anion rit  of 
development  work  upon  the  claim  each  year.  As  long  as  these  conditions 
are  performed,  the  appropriator  of  the  water  and  the  locator  of  the 
mining  claim  are  fully  protected  by  law  in  the  possession  of  the  respective 
properties.  A  water  right  is  not  an  intangible  thing,  l)ut  is  in  the  highest 
degree  tangible.  A  water  right  without  water  would  be  worth  sinii)iy 
nothing  at  all.  There  can  be  no  such  thing  as  a  water  right  with(jut 
water,  and  water  is  not  only  property  of  a  substantial  nature,  but  it  is 
included  in  the  class  of  the  highest  grade  of  property,  viz.,  real  property, 
and,  in  its  possession,  transfer,  and  enjoyment,  is  governed  generally 
by  the  same  laws  as  those  applying  to  land. 

"Nowhere  in  any  of  the  California  decisions  can  be  found  anj'  state- 
ment to  the  effect  that  a  water  right,  within  the  meaning  of  the  law,  is 
not  a  thing  of  value.  In  the  cases  referred  to,  the  decision  of  the  courts 
was  that  the  water  companies  had  no  water  rights  but  simplj'  franchises 
to  render  a  service.  Water  companies  engaged  solely  in  the  business  of 
distributing  and  selling  water  are  referred  to  as  agencies.  The  owner- 
ship of  the  water  is  regarded  as  being  still  in  the  people  and  the  compa- 
nies as  being  merely  invested  with  the  franchise  right  of  taking  the  water 
from  its  natural  channels  and  delivering  it  to  the  people  at  reasonar)le 
prices  for  the  service  rendered." 

******** 

"In  the  recent  case  of  Tonopah  Water  Company  vs.  PubHc  Service 
Commission  of  Nevada  the  attitude  of  Judge  Morrow  with  respect  to  the 
value  of  water  rights  was  made  entirely  clear.  The  case  of  San  Joaciuin 
and  Kings  River  C.  &I.  Company  vs.  Stanislaus  County,  in  191  Fed.,  was 
decided  about  two  years  before  the  hearing  was  had  in  the  Tonopah 
water  case.  And  yet  at  no  stage  of  the  proceeding  did  Judge  Morrow 
utter  a  word  which  gives  the  slightest  support  to  the  theory  that  the 
water  rights  of  a  public  service  corporation  are  not  to  be  considered  as  of 
value.  In  his  revised  opinion  that  distinguished  and  learned  judge 
accepts,  as  intrinsically  sound,  my  own  contention  made  when  actmg  as 
counsel  in  the  case,  that  the  Tonopah  Water  Company  had  no  'water 
right'  within  the  meaning  of  the  law;  that  the  only  water  it  possessed 
was  percolating  water,  and,  as  such,  a  part  and  parcel  of  the  soil.  The 
Court  held  substantially  in  accordance  with  this  view,  and  further  held 
that  there  was  no  evidence  that  the  Court  could  consider,  proving  the 
value  of  the  water  considered  as  a  water  right.  But  running  all  through 
the  Judge's  remarks  when  engaged  in  colloquy  with  the  attorneys,  as 
well  as  through  the  final  opinion,  was  a  clear  indication  of  the  view  that  a 
water  right  was  a  thing  of  value,  properly  to  be  considered  when  its  value 


150  VALUE  FOR  RATE-MAKING 

was  clearly  shown.  The  trouble  in  that  case  was  that  all  the  evidence 
offered  by  the  water  company  went  to  the  value  of  a  water  right,  per  se, 
while  it  was  made  very  apparent  that  there  was  no  such  water  right,  but 
that  the  company  was  simply  the  owner  of  a  piece  of  ground  saturated 
with  water."^ 

The  term  "water  rights"  is  used  indiscriminately,  whether 
applied  to  the  values  possessed  by  corporations  diverting  water 
for  irrigation  or  sanitary  purposes,  or  those  using  water  perhaps 
on  their  own  real  estate  for  power  development.  It  will  be 
recognized  that  the  value  for  the  former  purpose  in  any  particular 
instance  might  be  and  usually  is  quite  different  from  the  value  for 
power  purposes  and  vice  versa.  Consequently,  the  method  of 
measuring  or  determining  the  value  of  water  for  power  develop- 
ment may  not  be  applicable  in  determining  the  value  of  water  for 
diversion,  sanitation  or  irrigation. 

A  general  method  frequently  applied  to  determine  the  value  of 
any  class  of  water  rights  is  the  "next  available  source  of  supply." 
This  consists  in  estimating  the  excess  in  cost  of  plant  and  prop- 
erty, of  the  next  nearest  supply  that  might  be  made  available, 
above  or  beyond  the  existing  property,  which  excess  cost  is  used 
as  the  basis  from  which  to  derive  the  value  of  the  water  rights  of 
the  existing  property. 

"To  illustrate:  If  it  costs  $120  a  year  more  to  haul  farm  produce 
from  farm  A  than  from  farm  B,  and  if  money  is  worth  6  per  cent.,  then 
the  capitalized  value  of  this  $120  annual  difference  is  $2,000.  Hence, 
if  all  other  things  are  equal,  farm  B  has  a  value  of  $2,000  in  excess  of 
farm  A.  Similarly  if  a  distant  water  supply  A  causes  an  annual  cost 
that  is  $6,000  greater  than  is  incurred  with  supply  B,  then  supply  B 
has  a  value  of  $100,000  in  excess  of  supply  A,  if  money  is  worth  6  per 
cent."  2 

Where  the  power  is  being  developed  the  value  of  the  water 
rights  is  frequently  estimated  by  a  similar  method  except  that 
the  "next  available  source  of  supply"  is  not  another  water  power 
but  some  other  type  of  motive  power  such  as  steam  or  oil.  The 
Railroad  Commission  of  Wisconsin  early  appreciated  the  impor- 
tance of  this  method  of  evaluating  water  rights  and  in  several 
decisions  analyzed  and  discussed  the  method  but  only  recently 
accepted  such  engineering  calculations  as  the  basis  of  an  award. 

'  Pul)lic  Service  Commission  of  Nevada  vs.  Nevada  &  California  Power  Co.,  Jan.  29, 
1914,  pages  30-39. 

^  Engineering  <t  Contr acting,  .July  8,  1914. 


LAND,  PAVING,  AND  WATER  RICUTS  l.-ii 

The  views  of  the  Commission  are  {iiveu  in  tlic  tolldwintr  cxtiads 
from  its  decisions: 

"That,  as  a  rule,  water  powers  have  some  vahie  that  shouUl  he  con- 
sidered, but  there  are  wide  differences  of  opinion  as  to  what  tliese  vahics 
amount  to.  In  estimating  the  vahie  of  water  rights,  it  seems  to  bo  cuin- 
mon  practice  among  engineers  to  compute  what  it  would  cost  to  operate 
a  steam  plant  in  the  same  locaUty,  under  the  same  load  and  condi- 
tions. Finding  by  this  calculation  the  cost  per  horsepower  per  year  for 
the  steam  plant,  the  actual  cost  per  horsepower  per  year  of  the  existing 
water  power  plant  is  sul)tracted  therefrom,  and  the  saving  of  the  water 
power  over  the  steam  power,  as  shown  in  the  remainder,  is  called  the 
value  of  the  water  right.  In  this  way  steam  and  water  power  plants  are 
ostensibly  placed  on  the  same  basis. 

"From  a  purely  commercial  point  of  view  this  method  of  estimating 
the  value  of  water  power  may,  in  the  main,  be  sound.  But  it  is  not  .so 
clear  that  this  can  be  said  for  it  when  the  question  is  regarded  from  the 
point  of  view  of  pubUc  policy.  This  method,  as  stated,  places  water 
and  steam  plants  on  the  same  basis.  By  doing  this  it  necessarily  diverts 
all  the  advantages  that  may  accrue  from  such  water  powers  from  the 
pubhc  to  the  private  owners.  In  other  words,  it  appears  to  deprive  a 
locality  of  the  natural  advantages  it  might  otherwise  derive  from  being 
located  near  such  water  powers.  If  water  rights  are  private  property 
under  the  law,  then  all  the  benefits  which  accrue  from  these  rights  would 
probably  go  to  their  private  owners.  If,  on  the  other  hand,  water  j)o\v('r 
rights  are  public  rights  rather  than  private  rights,  then  it  would  also 
seem  that  the  public  ought  to  share  in  any  benefits  that  may  be  derived 
from  such  rights.  Just  what  the  law  is  in  this  respect,  is  a  matter  upon 
which  we  will  not  attempt  to  pass  at  this  time. 

"As  to  whether  the  respondent's  plant  can  generate  and  distribute  its 
current  at  relatively  lower  costs  than  a  modern  steam  plant  just  large 
enough  to  furnish  all  the  current  needed  for  the  city  of  Hudson,  is  not 
entirely  clear.  The  comparisons  we  have  made  and.  the  data  we  have 
collected  for  the  purpose  of  determining  this  question  indicate  a  small  dif- 
ference in  favor  of  the  present  plant.  At  any  rate,  the  present  plant 
appears  to  be  in  a  position  to  generate  current  at  a  somewhat  lower  cost 
than  a  steam  plant.  When  it  comes  to  the  distribution  of  the  current 
and  to  the  fixed  charges,  on  the  other  hand,  the  situation  would  almost 
seem  to  be  reversed,  for  the  distribution  expenses  and  the  fixed  charges 
of  the  present  plant  appear  to  be  fully  as  high  as  would  be  the  case  for  a 
steam  plant.  Some  of  the  reasons  for  this  are  found  in  the  location  of 
the  plant,  and  in  the  fact  that  the  present  plant  had  to  provide  and  has 
to  maintain  two  separate  dams  or  generating  stations  located  some  dis- 
tance apart,  and  also  some  distance  away  from  the  city.  To  ol)taiii 
absolutely  rehable  data  as  to  the  difference  in  relative  cost  of  furnishmg 


152  VALUE  FOR  RATE-MAKING 

light  and  power,  as  between  the  present  plant  and  a  substitute  steam 
power  plant,  is  a  very  difficult  matter,  there  being  a  scarcity  of  data  bear- 
ing upon  these  points.  While  the  facts  we  have  succeeded  in  obtaining 
indicate  that  the  present  plant  may  enjoy  some  advantages  in  this  respect, 
these  advantages  do  not  appear  to  be  as  great  as  expected,  nor  are  they 
as  clearly  established  as  they  should  be  in  order  to  furnish  a  safe  basis 
for  the  valuation  of  the  water  rights. 

"In  view  of  the  facts  thus  presented  with  respect  to  the  value  of  water 
power  rights,  and  in  view  of  the  further  fact  that  this  omission  would  not 
seem  to  affect  the  conclusions  in  this  case,  no  attempt  is  here  made  to 
value  the  water  power  rights  which  are  involved  in  this  case.  The 
elements  considered  in  the  valuation  of  the  physical  property  of  the 
plant  include,  of  course,  all  improvements  in  connection  with  the  water 
power.  "^ 

In  the  Beloit  case,  the  Wisconsin  Commission  says: 

"Expert  testimony  has  been  introduced  by  both  the  city  and  the 
company  in  regard  to  the  value  of  the  water  power  owned  by  the  respond- 
ent. The  company  claims  that  the  value  of  the  water  power  in  question 
is  at  the  lowest  estimate  $150,000.  The  city's  experts,  on  the  other  hand, 
while  conceding  that  a  certain  value  attaches  to  this  water  power,  will 
not  concede  the  lowest  value  claimed  by  the  company,  and  would  place 
the  value  as  between  $27,167  (Fowle's  report)  and  $50,000  (Evans' 
report).  The  staff  has  submitted  no  estimate  of  the  value  of  the  water 
power. 

"It  seems  clear  from  the  expressions  of  opinions  thus  made  and  from 
the  general  practice  of  engineers  and  other  men  in  valuing  water  powers 
that  the  saving  effected  by  the  use  of  the  water  power  over  steam  power, 
especially,  measures  the  value  of  the  water  power.  Other  methods  of 
appraisal  are  used  and  have  been  mentioned  by  the  witnesses  in  these 
proceedings,  namely,  rental  value  and  market  value.  These  latter 
methods,  however,  are  quite  often  open  to  objections  which  destroy 
their  reliability  and  it  appears  that  it  is  almost  always  necessary  to  fall 
back  upon  the  method  of  calculating  the  saving  over  steam  power  and 
then,  by  capitalizing  this  saving,  arrive  at  the  total  value  of  the  water 
power. 

"Referring  further  to  the  method  of  measuring  the  value  of  a  water 
right  by  the  saving  over  steam  power  effected  by  the  use  of  such  power,  it 
is  necessary  to  inquire  closely  into  the  relations  between  the  water  power 
and  steam  power  in  the  particular  plant  under  consideration,  for  it  is 
obvious  that  where  steam  power  is  necessary  as  an  auxiliary  to  the  water 
power,  that  the  saving  effected  in  such  case  cannot  be  measured  by  the 
actual  saving  with  the  steam  plant  operating  as  an  auxiliary.     Such  a 

•  5  W.  R.  C.  R.  Ro3s  et  al.  vs.  Burkhardt  Milling  &  Electric  Power  Co..  decided  Apr.  8. 
1910,  page  146. 


LAND,  PAVING,  AND  WATKh'  h'iC/lTS  i:,;i 

method  of  calculating  the  saving  and  thus  the  vahie  of  tlie  water  right 
would  result  in  a  larger  value  per  horsepower  for  the  imperfect  watj-r 
power  than  would  be  the  case  for  a  perfect  or  complete  water  ix)w<'r, 
calling  for  no  steam  auxiliary. "^ 

Nowhere  in  the  decision  is  any  fifrvnv  given  as  ostahlishing  a 
value  allowed  for  the  water  power,  which  apparently  was  imf  cr.ti- 
sidered  in  establishing  the  fair  present  value. 

As  will  be  seen  from  the  preceding,  the  Wisconsin  (  oimiiissiun 
has  indicated  for  several  years  a  leaning  toward  the  acceptance! 
of  the  theory  that  the  value  of  a  water  power  could  l)c  dctcnnincd 
from  a  consideration  of  the  saving  in  the  cost  of  an  ecpiivalcnt 
amount  of  energy  produced  in  a  steam  plant  or  other  coniparahh^ 
source  of  power.  In  the  recent  case  of  the  Rhinelandcr  Tower 
Company,  where  authority  was  sought  to  amend  rates,  the  Com- 
mission definitely  fixed  the  value  of  the  company's  water  power 
from  considerations  of  the  saving  in  expenses  resulting  from  the 
water  power  as  compared  with  "the  next  available  source  of 
supply"  a  steam  plant.  After  admitting  that  a  theoretical  saving 
of  $30,000  could  be  made  for  the  hydraulic  plant,  the  Commission 
holds  that  to  be  strictly  comparable  with  a  steam  plant,  the 
hydraulic  plant  would  require  an  auxiliary  steam  plant ;  the  cost 
of  operating  which,  together  with  fixed  charges,  would  amount  to 
$22,000,  leaving  an  actual  saving  of  "  only  about  $8,000  per  year." 
After  discussing  some  of  the  qualifying  conditions  of  the  case 
and  apparently  capitalizing  the  net  saving  of  $8,000  upon  a  10 
per  cent,  basis,  the  Commission  concludes 

•'with  these  facts  in  mind  it  appears  that  $80,000  is  about  a  maximuin 
value  that  could  be  fairly  allowed  for  the  water  power  rights  under 
present  conditions.  This  amount  added  to  the  value  of  the  physical 
property,  working  capital  and  going  value,  bring  the  total  valuation  to 
approximately  $200,000. "^ 

The  New  Hampshire  Public  Service  Commission  refused  to 
fully  accept  the  theory  that  the  value  of  water  power  could  he 
fixed  by  capitalizing  its  saving  in  the  production  of  energy  as 
compared  with  the  cost  of  fuel,  saying: 

"Water  power  has  value,  if  it  produces  energy  at  a  sufficient  saving 
over  coal  to  offset  the  disadvantages  attendant  upon  its  variai)le  pro- 

1  7  W.  R.  C.  R.  City  of  Beloit  vs.  Beloit  Water,  Gas  &  Electric  Co.,  July  19,  1911,  paRc 
187. 

2  Decision  of  the  R.  R.  Com.  of  Wiscousin,  Jan.  30,  1915,  in  r^  application  of  the  Rhino- 
lander  Power  Co.  for  authority  to  establisli  an  amended  schedule  of  rates,  l-">  W.  H.  C.  R.  800. 


154  VALUE  FOR  RATE-MAKING 

duction.  But  the  entire  saving  over  coal,  calculated  on  the  total 
annual  production  of  power,  and  capitalized,  certainly  far  exceeds  the 
value  of  the  power — what  one  would  pay  for  it  as  a  substitute  for  a 
steam  plant.     *  *  * 

"One  feature  of  the  'saving  over  coal'  method  of  determining  the 
value  of  a  water  power  should  not  escape  attention.  We  live  in  a 
region  remote  from  the  coal  fields,  the  cost  of  transportation  is  heavy, 
and  the  price  of  coal  is  higher  than  in  almost  any  other  part  of  the 
country.  On  the  other  hand,  ours  is  a  mountainous  State,  with  many 
streams  having  a  large  fall  and  furnishing  an  abundance  of  water 
power,  much  of  which  is  still  undeveloped.  If  we  adopt  the  policy  of 
valuing  water  powers  in  rate  and  capitalization  cases  by  capitalizing 
their  saving  over  coal,  the  people  of  the  State  are  left  subject  to  all  the 
disadvantages  attendant  on  remoteness  from  the  coal  mines,  while 
enjoying  no  advantage  from  living  in  a  region  abundantly  supplied 
with  water  powers.  A  'fair  value'  of  a  water  power  in  New  Hampshire 
cannot  be  a  value  which  takes  no  account  of  our  natural  resources,  and 
makes  electricity  produced  by  water  as  expensive  to  the  public  as  if 
produced  by  coal.  *  *  * 

"The  evidence  as  to  their  value  on  a  coal  saving  basis  has  been 
given  due  consideration,  but  cannot  be  accepted  as  a  final  test  of 
value. "^  *  *  * 

The  Railroad  Commission  of  the  State  of  California  has  until 
recently,  consistently  refused  to  recognize  that  utilities  have  any 
property  values  in  water  rights. 

In  the  recent  case,  No.  1370,  of  the  Eureka  Water  Company, 
where  this  Commission  was  fixing  the  compensation  to  be  paid 
by  the  city,  the  company  computed  the  value  of  its  water  rights 
on  two  bases,  the  additional  cost  that  would  be  incurred  by  bring- 
ing the  next  available  source  of  water  into  Eureka  and  an  arbi- 
trary price  per  million  gallons  supplied,  each  basis  resulting  in  a 
value  of  $100,000.  While  omitting  a  discussion  of  the  propriety 
of  a  value  of  water  rights,  the  Commission  rejects  the  theory  of 
the  next  available  supply  as  absolutely  untenable  as  determining 
the  value  of  the  existing  supply  or  for  any  purpose  whatsoever, 
stating  that  such  cost  has  no  reference  to  the  value  of  any  right 
to  take  water  from  the  existing  source  of  supply.  Similar  con- 
clusions, as  to  the  absence  of  value  in  water  rights,  were  held  in  the 
Northern  California  Power  Company  case  decided  July  13,  1913, 
and  others.  These  rulings  of  the  California  Commission  are  of 
particular  interest  because  the  Supreme  Court  of  the  United 

'  Petition  of  Grafton  Electric  laght  &  Power  Co.,  decided  Feb.  3,  1914,  by  New  Hmapshire 
Public  Service  Coiumission. 


LAND,  PAVING,  AND  WATER  mmiTS  i-jo 

States  has  recently  decided  in  the  case  of  a  Cahfornia  corporation 
that  even  for  rate-making  purposes  the  value  of  water  rights  must 
be  determined  and  included  as  a  part  of  the  property  upon  wliidi 
returns  are  to  be  allowed.  This  decision  being  supreme  and 
final  will  probably  henceforth  compel  recognition  of,  and  allow- 
ance for  water  rights  as  a  part  of  the  property  which  must  Ix- 
valued,  where  title  to,  or  control  of  such  belongs  to  the  utiHty 
being  regulated. 

The  decision  referred  to  was  handed  down  Apr.  27,  1911,  and 
is  so  illuminating,  and  of  such  importance  as  to  warrant  rather 
full  explanation  and  quotation. 

The  ruling  was  made  in  the  suit  of  the  San  Joaquin  &  Kings 
River  Canal  &  Irrigation  Co.,  against  the  County  of  Stanislaus  et 
al.  to  restrain  the  enforcement  of  orders  of  the  Boards  of  Super- 
visors of  Stanislaus,  Fresno  and  Merced  Counties,  fixing  rates 
allowing  a  6  per  cent,  return  on  tangible  property,  but  giving  no 
consideration  to  the  water  rights  claimed  by  the  appellant. 

The  Supreme  Court  confined  its  opinion  solely  to  the  question 
of  whether  water  rights  should  be  given  consideration  in  evalu- 
ating property  for  rate-making  purposes.  The  defendants 
refused  to  make  such  allowance,  and  in  this  position  they  were 
sustained  by  the  Circuit  Court,  191  Fed.  Rep.  875.  The  United 
States  Supreme  Court  said: 

"The  bill  (to  restrain  the  enforcement  of  orders  passed  by  the  Boards 
of  Supervisors  of  the  three  defendant  Counties,  Stanislaus,  Fresno  & 
Merced,  establishing  water  rates  to  be  charged  by  the  plaintiff)  concerns 
rates  fixed  in  1907  and  the  question  before  the  court  has  been  narrowed 
to  a  single  issue.  If  the  plaintiff  is  entitled  to  6  per  cent,  upon  its 
tangible  property  alone,  it  is  agreed  that  the  orders  must  stand.  But 
if  the  plaintifif  has  water  rights  that  are  to  be  taken  into  account,  the 
rates  fixed  will  fall  short  of  giving  it  what  it  is  entitled  to  and  must  be 
set  aside.  *  *  *  The  Circuit  Court  dismissed  the  bill,  191  Fed.  Rep. 
875  and  on  this  appeal  figures  are  immaterial,  the  only  question  being 
whether  the  principle  adopted  is  right. 

"It  is  not  disputed  that  the  plaintiff  has  a  right  as  against  riparian 
proprietors  to  withdraw  the  water  that  it  distributes  through  its  canals. 
Whether  the  right  was  paid  for,  as  the  plaintiff  says,  or  not,  it  has  been 
confirmed  by  perscription  and  is  now  beyond  attack.  It  is  not  ths- 
puted  either  that  if  the  plaintiff  were  the  owner  of  riparian  lands  of  which 
its  water  was  distributed,  it  would  have  a  property  in  the  water  that 
could  not  be  taken  without  compensation.  But  it  is  said  that  as  the 
plaintiff  appropriates  this  water  to  distribution  and  sale,  it  thereby 


156  VALUE  FOR  RATE-MAKING 

dedicates  it  to  public  use  under  California  law  and  so  loses  its  private 
right  in  the  same.  It  appears  to  us  that  when  the  cases  cited  for  this 
proposition  are  pressed  to  the  conclusion  reached  in  the  present  case, 
they  are  misapplied.  No  doubt  it  is  true  that  such  an  appropriation 
and  use  of  the  water  entitles  those  within  reach  of  it  to  demand  the  use 
of  a  reasonable  share  on  payment.  It  well  may  be  true  that  if  the  waters 
were  taken  for  a  superior  use  by  eminent  domain  those  whose  lands 
were  irrigated  would  be  compensated  for  the  loss.  But  even  if  the  rate 
paid  is  not  to  be  determined  as  upon  a  purchase  of  water  from  the  plain- 
tiff, still,  at  the  lowest,  the  plaintiff  has  the  sole  right  to  furnish  this 
water,  the  owner  of  the  irrigation  lands  cannot  get  it  except  through  the 
plaintiff's  help,  and  it  would  be  unjust  not  to  take  that  fact  into  account 
in  fixing  the  rates.  We  are  not  called  upon  to  decide  what  the  rate  shall 
be,  or  even  the  principle  by  which  it  shall  be  measured.  But  it  is 
proper  to  add  a  few  words. 

"The  declaration  in  the  Constitution  of  1879  that  water  appropriated 
for  sale  is  appropriated  to  a  public  use  must  be  taken  according  to  its 
subject  matter.  The  use  is  not  by  the  pubHc  at  large,  like  that  of  the 
ocean  for  sailing,  but  by  certain  individuals  for  their  private  benefit 
respectively.  Thayer  vs.  Cal.  Development  Co.,  164  Cal.  117,  128 — 
Fallbrook  Irrigation  District  vs.  Bradley,  164  U.  S.  112,  161.  The 
declaration,  therefore,  does  not  necessarily  mean  more  than  that  the 
few  within  reach  of  the  supply  may  demand  it  for  a  reasonable  price. 
The  roadbed  of  a  railroad  is  devoted  to  a  public  use  in  a  stricter  sense, 
j^et  the  title  of  the  railroad  remains,  and  the  use  though  it  may  be 
demanded,  must  be  paid  for.  In  this  case  it  is  said  that  a  part  of  the 
water  was  appropriated  before  the  Constitution  went  into  effect,  and 
that  a  suit  now  is  pending  to  condemn  more  as  against  a  riparian  pro- 
prietor, for  which,  of  course,  the  plaintiff  must  pay.  It  seems  unrea- 
sonable to  suppose  that  the  Constitution  means  that  if  a  party  instead  of 
using  the  water  on  his  own  land,  as  he  may,  sees  fit  to  distribute  it  to 
others  he  loses  the  rights  that  he  has  bought  or  lawfully  acquired. 
Recurring  to  the  fact  that  in  every  instance  only  a  few  specified  indi- 
viduals get  the  right  to  a  supply,  and  that  it  clearly  appears  from  the 
latest  statement  of  the  Supreme  Court  of  California,  Palmer  vs.  Rail- 
road Commission,  Jan.  20,  1914,  47  Cal.  Dec.  201,  that  the  water  when 
appropriated  is  private  property,  it  is  unreasonable  to  suppose  that  the 
constitutional  declaration  meant  to  compel  a  gift  from  the  former  owner 
to  the  users  and  that  in  dealing  with  water  appropriated  for  sale  it 
meant  that  there  should  be  nothing  to  sell.  See  San  Diego  Water  Co. 
vs.  San  Diego,  118  Cal.  556,  567 — Fresno  Canal  &  Irrigation  Co.  vs. 
Park,  129  Cal.  437,  443,  et  seq.  Stanislaus  Water  Co.  vs.  Bachman, 
152  Cal.  716,  Leavitt  vs.  Lassen  Irrigation  Co.,  157  Cal.  82.  Decree 
reversed."^ 

'  233  U.  S.  459. 


CHAPTER  VII 

FRANCHISES,  WORKING  CAPITAL  AND  BOND 
DISCOUNTS 

Franchises. — Almost  without  exception  the  State  puhlic 
utiUty  commissions  have  held,  and  the  various  courts  have 
frequently  ruled,  that  a  public  utility  corporation  has  no  right 
to  capitalize  its  franchise,  particularly  for  rate-makinp;.  Tiiis 
ruling  has  been  the  same  whether  the  franchise  is  exclusive, 
perpetual,  limited  to  a  definite  term  of  years,  or  of  the  "in- 
determinate" type.  The  usual  argument  for  the  justification 
of  such  ruling  is,  that  the  public,  having  granted  the  franchise, 
should  not  be  compelled  to  pay  a  return  thereon.  The  conclusion, 
however,  is  not  entirely  warranted.  There  can  be  no  question 
but  what  the  rights  that  may  have  been  granted  under  a  franchise 
were  once  owned  by  the  public  but  they  were  parted  with  for  a 
particular  purpose  and  in  consideration  of  the  carrying  out  of 
certain  obligations,  which,  as  long  as  fulfilled  binds  the  grantor. 
As  a  rule,  the  utilities  have  omitted  to  make  any  claim  for  value 
of  franchise  in  the  same  way  that  going  value  has  not  been 
claimed  in  many  instances.  This  omission  of  claim  for  value  has 
been  perhaps  an  error,  as  it  may  well  be  argued  that  a  franchise 
which  was  given  some  years  ago,  as  an  absolute  conveyance,  as 
an  inducement  to  the  investment  of  capital,  and  the  development 
of  a  public  utility  should  have  its  value  recognized  and  return 
thereon  allowed  the  same  as  any  other  donation.  Years  ago, 
when  the  Federal  Government  was  anxious  to  have  transcon- 
tinental railroads  built  to  the  Pacific  Coast,  it  gave  outright 
thousands  of  acres  of  land  adjacent  to,  and  in  addition  to,  the 
right-of-way,  in  order  to  induce  the  investment  of  the  necessary 
capital  to  build  the  railroads.  This  land  never  cost  anything 
more  than  most  franchises  have  in  the  past.  The  Supreme  Court 
has  repeatedly  and  distinctly  held  that  railroads  have  unques- 
tionable title  to  the  land  received  as  a  donation  from  the  govern- 
ment, and  that  they  are  justified  in  demanding  returns  on  its 
full  present  value.     Not  many  months  ago  the  Supreme  Court 

157 


158  VALUE  FOR  RATE-MAKING 

decided  in  favor  of  the  Southern  Pacific  Railway  against  claim- 
ants to  mineral  lands,  worth  approximately  $700,000,000, 
which  had  originally  been  given  to  the  railroad  by  the  Govern- 
ment. Reference  has  already  been  made,  on  page  47,  to  the 
recent  decision  of  the  Supreme  Court  in  confirming  the  cor- 
poration's title  to  land  given  by  the  Government  under  the 
Oregon  and  California  Railroad  Land  Grant.  It  would  seem  no 
less  fair  or  logical  to  recognize  the  value  of  franchises  granted 
by  the  public  without  cost — admitting  the  difficulty  of  fixing  the 
fair  value — than  to  allow  the  value  of  donated  real  estate.  This 
view  has  been  sustained  in  certain  instances,  notably  in  the  Con- 
solidated Gas  Company  case  where  the  Court,  sustaining  an 
allowance  of  $7,781,000  as  the  value  of  a  franchise,  said: 

"It  cannot  be  disputed  that  franchises  of  this  nature  are  property  and 
cannot  be  taken  and  used  by  others  without  compensation."^ 

In  the  Kennebec  Water  District  case,  the  Court  stated: 

"The  defendants'  request  11  should  be  given  in  this  case.  It  has 
been  given  in  part  already.  It  is  that  the  value  of  a  franchise  depends 
upon  its  net  earning  power,  present  and  prospective,  developed  and 
capable  of  development,  at  reasonable  rates,  that  the  value  to  be  assessed 
is  the  value  to  the  seller  and  not  to  the  buyer,  and  that  'just  compensa- 
tion' means  full  compensation  for  everything  or  element  of  value  taken. 
Monongahela  Nav.  Co.  vs.  United  States,  swpra.  The  appraisal  must 
be  made,  having  in  mind  what  we  have  already  said,  concerning  the  char- 
acter and  duration  of  the  franchises  and  the  reasonableness  of  rates. 
While  with  these  limitations,  the  owner  is  entitled  to  receive  the  value 
of  the  franchises,  having  reference  to  their  prospective  use  as  now  de- 
veloped, and  to  the  future  development  of  their  use,  consideration  must 
also  be  had  of  the  fact  that  further  investment  may  be  necessary  to 
develop  the  use,  and  of  the  further  fact  that  at  any  stage  of  development 
the  owner  of  the  franchise  will  be  entitled  to  charge  only  reasonable 
rates  under  the  conditions  then  existing.  But,  subject  to  such  limita- 
tions, we  think  it  should  be  said  that  the  owner  is  entitled  to  any  appre- 
ciation due  to  natural  causes,  such  as,  for  instance,  the  growth  of  the 
cities  or  towns  in  which  the  plant  is  situated.  Cotting  vs.  Kansas  City 
Stock  Yards  Co.,  82  Fed.  Rep.,  850."^ 

In  the  Monongahela  Navigation  Company  case  above  referred 
to,  Congress  had  passed  an  Act  providing  for  the  condemnation 

'  Wilcox  vs.  Consolidated  Gas  Co.,  212  U.  S.  44. 

^  Kennebec  Water  District  vs.  Waterville,  97  Me.  18o. 


FRANCHISES,  WORKING  ('API TAL,  DISCO ( W TS    l .V.i 

of  the  property  of  the  Navigation  Company,  and  spcci Ileal ly 
provided  that  no  compensation  should  be  paid  for  the  franchise 
right  to  take  tolls.  The  Supreme  Court  held  that  this  provision 
as  to  franchise  right  was  in  violation  of  the  Fifth  Amendmcnl  of 
the  Constitution,  saying: 

"So,  before  this  property  can  be  taken  away  from  its  owners,  llie 
whole  value  must  be  paid;  and  that  value  depends  largely  upon  the  pro- 
ductiveness of  the  property,  the  franchise  to  take  tolls. 

"The  franchise  is  a  vested  right.  The  State  has  power  to  grant  it. 
it  may  retake  it,  as  it  may  take  other  private  property,  for  puljjic  uses, 
upon  the  payment  of  just  compensation.  A  like,  though  a  superior, 
power  exists  in  the  national  government.  It  may  take  it  for  i)ublic 
purposes,  and  take  it  even  against  the  will  of  the  State;  but  it  can  no 
more  take  the  franchise  which  the  State  has  given  than  it  can  any  pri- 
vate property  belonging  to  an  individual."^ 

In  the  Spring  Valley  Water  Company  case,  the  Court  said: 

"That  a  franchise  is  property  has  been  declared  by  the  Constitution 
and  affirmed  repeatedly  by  the  Supreme  Court  of  the  State  of  Cali- 
fornia."^ 

The  Railroad  Commission  of  Wisconsin  has  recently  said, 
in  fixing  the  value  of  corporation  property  to  be  purchased 
by  a  municipality: 

"Even  if  the  city  could  lawfully  condemn  the  franchise  of  the  com- 
pany, it  would  not  be  benefited  thereby  to  any  material  extent.  .Vs 
the  franchise  is  essential  to  the  operation  of  the  property,  any  damage 
for  taking  such  franchise,  separate  and  apart  from  the  property,  would, 
under  any  valid  law,  result  in  requiring  the  municipality  to  pay  the 
difference  in  the  value  of  the  property,  including  the  franchise  before 
and  after  the  taking  of  the  franchise."^ 

"It  is  suggested  in  the  opinion  by  Commissioner  Shaughnessy  that, 
as  a  rule,  the  courts  have  held  that  franchises  have  no  value  for  rate- 
making  purposes.  But  he  says  that  the  case  of  Willcox  vs.  Consolidated 
Gas  Company,  in  the  212  U.  S.  19,  is  an  exception  to  the  rule.  So  far 
from  such  being  the  case,  as  I  have  read  the  authorities,  the  Willcox 
case  in  the  212  U.  S.  supra,  is  not  an  exception  to  the  rule,  but  states 
the  rule.  And,  what  is  of  the  first  importance  in  this  case,  it  is  a  rule 
established  by  the  highest  tribunal  in  this  country,  viz.,  the  Supreme 
Court  of  the  United  States. 

•  Monongahela  Navigation  Co.  vs.  U.  S.  148,  U.  S.  329,  341. 

^  Spring  Valley  Water  Company  vs.  San  Francisco,  165  Fed.  607. 

^  Neenah  vs.  Wisconsin  TracUou  Light,  Heat  «fc  Power  Co.,  P.  U.  U.  1913.     A,  372. 


160  VALUE  FOR  RATE-MAKING 

"In  the  case  of  Willcox  vs.  Consolidated  Gas  Company  the  Court  dis- 
tinctly recognized  the  fact  that  the  franchise  was  property  and  that  it 
had  a  value  to  be  considered  for  purposes  of  rate-making.  All  that  the 
Court  said  which  points  toward  sustaining  my  associate's  contention, 
is  that  there  was  no  evidence  in  the  case  that  justified  the  lower  court, 
in  allowing  an  increased  valuation  for  the  franchise  over  and  above  that 
which  has  been  given  to  it  at  an  earlier  date.  The  increased  valuation, 
from  more  than  seven  millions  of  dollars  to  twelve  millions  of  dollars, 
was  based  simply  upon  the  reasoning  of  the  court  below  that  the  value  of 
the  franchise  should  increase  pro  rata  with  the  increase  of  the  business. 
This,  though,  was  rejected  by  the  Supreme  Court,  and,  as  I  think, 
properly. 

"If  we  turn  to  page  44  of  the  volume  mentioned,  we  find  tliis 
language: 

"It  cannot  be  disputed  that  franchises  of  this  nature  are  property, 
and  cannot  be  taken  or  used  by  others,  without  compensation.  (Citing 
Monongahela  Company  vs.  United  States,  148  U.  S.  312;  people  vs. 
O'Brien,  111  N.  Y.  L.  and  cases  cited).  The  important  question  is 
always  one  of  value. 

"From  the  foregoing,  it  will  be  seen  that  the  Supreme  Court  of  the 
United  States  had  previously  decided  the  same  question  the  same  way 
and  that  the  highest  court  in  the  great  State  of  New  York,  a  court 
second  in  dignity  only  to  that  of  the  Supreme  Court  of  the  United 
States,  had  done  the  same."^ 

A  series  of  important  decisions  in  the  matter  of  franchise 
value  have  recently  been  handed  down  by  the  New  Jersey  Courts. 
The  Board  of  Utility  Commissioners  of  New  Jersey,  in  fixing  the 
rates  in  the  Passaic  District,  for  the  Public  Service  Gas  Company, 
allowed  30  per  cent,  of  the  value  assigned  to  the  structural  plant 
to  cover  the  value  of  the  intangible  property.  As  the  Com- 
missioners expressly  stated,  the  allowance  included  everything 
outside  the  tangible  property,  also:  "the  entire  value  of  all 
franchises  primarily  or  secondarily,  possessed  or  exercised  by  the 
Company  in  the  Passaic  Division."  The  Corporation  appealed 
from  the  decision  of  the  Commissioners,  holding  that  no  proper 
recognition  of  and  allowances  for  franchise  had  been  made  in  the 
value  fixed  for  the  company's  property.  The  case  was  passed 
on  by  the  Supreme  Court  of  New  Jersey,  which,  after  review- 
ing the  law  in  the  case,  stated: 

1  Public  Service  Commission  of  Nevada  vs.  The  Nevada-California  Power  Company, 
decided  .Tan.  20,  1914. 


FRANCHISES,  WORKING  (WriTAL,  DTSroiXTS    ic.i 

"Logically,  no  allowance  should  be  made  tor  the  value  of  the  special 
franchise  in  a  case  where  it  is  not  legally  exclusive  and  where  the  St, -if i- 
still  retains  the  right  to  fix  rates."' 

The  Corporation,  not  satisfied  with  this  decision  of  t  lie  Suiircinc 
Court,  appealed  to  the  New  Jersey  Court  of  Errors  and  Api>cals, 
which  Court,  after  first  rendering;  a  decision  in  Dcceinhor,  1914,  in 
which  it  said:  "We  find  ourselves  unable  to  concur  in  this 
result,"  reversed  the  Supreme  Court;  later,  in  .liinc,  I!)!."),  after 
rehearing  upon  further  appeal  the  same  Court  reversed  its  own 
previous  decision  and  sustained  the  decision  of  the  Supreme 
Court.  The  Court,  speaking  through  Judge  White,  rendered 
an  important  opinion  from  which  the  following  passage  is  well 
worth  repeating  here: 

"Taking  up  the  second  proportion,  that  the  company's  charter  right 
to  charge  reasonable  rates  is  in  itself  a  valuable  property  right  entitled 
to  consideration  in  rate-making,  I  suppose  it  must  be  conceded  that 
the  franchise  to  charge  as  a  'reasonable  rate,'  sufficient  to  yield  a  net 
profit  of  8  per  cent,  on  the  value  of  the  company's  property,  as  allowed 
and  established  respectively  by  the  findings  of  the  Utilities  Commission 
in  this  case,  is  a  very  valuable  property  right.  Certainly  I  think  it 
is.  That  this  valuable  privilege  is  the  company's  is  beyond  question. 
That  it  is  property  is  undoubted.  That  the  law  protects  it  against  con- 
fiscation and  subjects  it  to  taxation  follows  as  a  matter  of  course." 

"But  that  this  valuable  property  right  to  charge  'reasonable  rates' 
should  by  virtue  of  its  own  existence  have  the  effect  of  converting  itself 
into  a  still  more  valuable  property  right  to  charge  'unreasonable  rates' 
is,  of  course,  preposterous.  Presumably  the  incorporators  went  into 
this  public-utility  business  because  they  expected  that  their  charter 
privilege  to  charge  'reasonable  rates'  for  the  gas  they  were  to  manu- 
facture, distribute  and  sell  would  be  a  valuable  one,  but  that  fact  and 
the  fact  that  it  has  become  so  cannot  have  the  effect  of  altering  the 
terms  of  the  contract  made  with  the  State      ..." 

The  Court  then  discusses  the  basis  of  reasonable  rates  and 
concludes  with  the  statement  that: 

"The  plain  fact  is  that  the  commercial  value  of  the  company's  prop- 
erty right  in  its  franchise  can  have  no  effect  in  fixing  the  rate  it  can  charge, 
because  by  the  terms  of  its  contract  with  the  State  the  stream  of  its 
franchise  value  arises  from  the  spring  of  its  right  to  charge  'reasonable 

'  84  N.  J.  L.  482. 
11 


162  VALUE  FOR  RATE-MAKING 

rates,'  and  in  the  very  nature  of  things  no  stream  can  rise  higher  than 
its  source."^ 

Under  the  regime  that  has  heretofore  existed,  the  franchises 
granted  pubHc  utihty  corporations  will  be  found  to  have  greater 
or  less  value  because  being  perpetual,  or  having  a  definite  term 
of  life,  unless  there  is  a  contract  stipulation  that  the  rights 
given  thereunder  should  be  without  value  as  against  the  donor. 
Consequently,  some  value  perhaps  merely  nominal,  or  an 
estimated  amount  commensurate  with  the  value  may  be  recog- 
nized in  the  appraisal  of  utility  property. 

Even  when  the  fact  is  clearly  recognized  and  admitted, 
that  a  franchise  is  a  contract  between  the  pubhc  and  the  utility, 
and  has  value,  the  determination  of  the  value  of  the  franchise  is 
not  easy.  In  case  a  definite  value  of  franchise  has  been  recog- 
nized by  proper  public  authorities,  as  in  the  case  of  the  Consoli- 
dated Gas  Company,  or  in  case  definite  payments  have  been  made 
in  order  to  secure  a  franchise,  the  value  for  rate-making  is  easily 
fixed.  In  cases  where  public  authorities  are  now  granting 
franchises  on  the  basis  of  some  uniform  charge  the  value  of  an 
equivalent  franchise,  free  of  any  charge  burdens,  could  be 
valued  upon  the  basis  of  capitalizing  the  net  savings.  It  is  self- 
evident  that  the  franchise  value  for  rate-making  purposes 
cannot  be  properly  and  equitably  obtained  by  capitalizing  net 
earnings,  although  such  method  is  applicable  where  rates  are  rea- 
sonable or  the  determination  of  value  is  necessary  for  purchase 
and  sale.  For  the  latter  purpose  the  accounting  process  is  to 
determine  the  present  worth  of  future  net  earnings  on  the  basis 
of  carrying  out  of  franchise  obligations  and  maintenance  of  the 
utility  property.  The  determination  must,  of  course,  take  into 
account  the  annual  operations  of  the  utility  throughout  the 
successive  remaining  years  of  the  life  of  the  franchise.  Where  a 
utility  is  charged  for  its  franchise  by  the  public  authorities,  the 
entire  cost  of  the  franchise  is  borne  by  the  consumers,  whether 
it  is  amortized  during  the  life  of  the  franchise  or  treated  as  a 
permanent  investment  entitled  to  a  fair  return;  hence  a  franchise 
charge  is  merely  an  indirect  collection  of  taxes. 

A  very  excellent  summary  of  the  effect  of  charges  being  made 
for  the  granting  of  franchises  has  been  given  by  the  Wisconsin 
Railroad  Commission  in  one  of  its  earliest  cases. 

>  Public  Service  Gas  Co.  vs.  Board  of  Public  Utility  Commissioners,  94  Atl.  634. 


FRANCHISES,  WORKING  CAPITAL,  DISCOUNTS    103 

"Franchises  are  not  always  obtained  without  cost.  Many  of  tlicrii 
include  provisions  which  entail  outlays  that  may  be  charged  either  to  the 
capital  account  or  the  operating  expenses.  The  former  may  consist  of 
considerations  in  the  form  of  stipulated  payments  to  the  municipality, 
license  fees,  a  certain  amount  of  free  service  upon  which  values  can  be 
placed,  and  other  items  of  this  character.  The  latter  may  include  the 
upkeep  of  streets  and  other  property,  extra  services  of  various  kinds, 
and  other  items  of  a  similar  nature.  The  former,  again,  would  secni  to 
be  as  much  a  part  of  the  investment  in  the  plant  and  in  its  business  as 
the  cost  of  the  physical  plant,  and  there  would  appear  to  be  the  best  of 
reasons  why  such  costs  should  be  included  in  the  value  of  the  plant  for 
rate-making  purposes.  The  latter  would  also  appear  to  be  legitimate 
charges  to  the  operating  expenses.  In  fact,  we  can  see  no  valid  reason 
to  the  contrary.  Both  would  seem  to  be  just  charges  against  the  con- 
sumers. Both  tend  to  increase  the  expenses,  and  consequently  the 
rates,  and  these  increases  would  seem  to  be  fair  and  equitable  to  all 
concerned."^ 

In  the  case  of  a  perpetual  franchise,  or  "indeterminate" 
permit,  no  annual  expense  or  charge  to  provide  a  fund  to  amortize 
the  value  of  the  property  is  necessary  for  inclusion  in  the  items 
going  to  make  up  the  sum  total  of  operating  charges  to  be  borne 
by  the  public.  On  the  other  hand,  where  a  franchise  is  limited 
to  a  definite  term  of  years,  the  value  of  the  property,  less  scrap 
value,  must  be  amortized  during  the  life  of  the  franchise,  thereby 
increasing  the  annual  charge  on  the  customers;  the  greater,  the 
shorter  the  hfe  of  the  franchise.  This  principle  has  been  authori- 
tatively recognized  in  the  decision  of  the  Pubhc  Service  Com- 
mission of  New  York,  Second  District,  in  the  Cataract  Power 
and  Conduit  Company  case,  where  the  Commission  says: 

"The  subject  of  general  amortization  has  been  necessarily  discussed 
somewhat  fully  under  the  head  of  depreciation,  of  which  it  is  essentially 
a  part.  It  appears  from  that  discussion  that  the  company  has  been 
handling  its  amortization  upon  the  theory  that  the  term  of  life  to  be 
reckoned  with  was  the  term  of  its  franchise,  which  expires  Jan.  14,  1912. 
It  has  collected  a  large  sum  of  money  from  the  public  upon  that  theory, 
which  sum,  if  properly  invested,  will  amount  at  the  end  of  the  term  to 
upward  of  $1,000,000.  It  may  also  be  assumed  that  the  company  has 
practically  proceeded  upon  the  theory  of  a  sinking  fund  invested  m 
outside  securities.  In  fact,  a  very  considerable  amount  is  actually 
thus  invested.  *  *  *  Since  practically  the  company  should  be 
allowed  to  earn  returns  upon  the  investment  value  of  all  its  property  in 

1  Hill  vs.  Antigo  Water  Co.,  3  W.  R.  C.  R.  023. 


164  VALUE  FOR  RATE-MAKING 

the  public  service  irrespective  of  the  source  from  which  tlie  money  was 
derived,  we  are  compelled  to  adhere  to  the  theory  of  the  sinking  fund 
invested  in  outside  securities. 

"Deducting  from  the  total  investment  value  of  the  property  in  ser- 
vice the  value  of  the  land  as  non-depreciable,  the  working  capital,  the 
materials  and  supplies,  and  making  proper  allowance  for  scrap  value  of 
the  depreciable  property,  the  Commission  finds  that  the  total  depre- 
ciable property  amounts  to  $1,760,663.  The  sinking  fund  already  pro- 
vided will  take  care  of  $1,065,968  of  this.  Hence  there  is  depreciable 
property  to  the  amount  of  $694,695  which  should  be  amortized  during 
the  20  years  of  the  franchise  term  remaining  unexpired  Jan.  14,  1912." 

"It  may  be  observed,  however,  that  the  amount  which  is  to  be  amor- 
tized of  the  present  capital  of  the  company,  both  tangible  and  intangible, 
after  making  all  suitable  deductions  for  scrap  values  and  property  which 
is  not  subject  to  amortization,  amounts  to  $1,760,663,  leaving  a  net 
amount  to  be  provided  for  of  $694,695,  which  would  require  an  annual 
payment  into  the  sinking  fund  of  $23,342."^ 

Capitalization  of  franchise,  aside  from  actual  expenditures 
required  by  the  public  regulating  body  granting  such  franchise, 
has  no  proper  warrant  in  an  ideal  system  of  public  utility  control 
and  regulation.  Exercising  the  right  to  regulate  rates,  the  rate- 
fixing  body  must  take  into  consideration  and  include  as  a  part  of 
operating  expenses,  to  be  paid  by  the  public  for  the  service 
rendered,  any  addition  to  the  operating  cost  incurred  by  taxes 
that  may  be  imposed  by  the  public,  either  in  the  way  of  a  fair 
return  to  be  allowed  on  the  capital  invested  in  the  original 
purchase  price  of  a  franchise,  or  as  a  toll,  or  levy  on  earnings 
or  property.  There  is  nothing  in  such  tax  that  tends  to  improve 
service,  or  reduce  rates;  in  fact,  the  exact  contrary  is  more 
hkely  to  result  because  operating  expenses  must  embrace  all  fair 
and  reasonable  costs  including  taxes  which  thus  become  a  further 
burden  on  the  users  of  the  utility  service.  Taxing  a  public 
utility  is  merely  an  indirect  method  of  having  its  customers 
contribute  to  the  public  purse  without  thoroughly  understanding 
and  appreciating  the  fact  that  they  are  not  getting  minimum 
rates  for  service  rendered.  There  is  no  sound  logical  or  economic 
reason  for  compelling  a  public  utility  to  include  tolls  or  taxes,  in 
its  annual  operating  expenses. 

The  relations  between  the  owners  of  a  public  utility  property, 
operating  a  limited  franchise,  and  the  public  are  similar  to  that 

'  Public  Service  Commission,  State  of  New  York,  Second  District,  Louis  P.  Fuhrmann 
vs.  The  Cataract  Power  &  Conduit  Company,  Decided  Apr.  2,  1913,  pages  71-9. 


FRANCHISES,  WORKING  CAPITAL,  DISCOUNTS    icr, 

of  a  capitalist  who  advances  money  under  a  mortKUKe  on  im- 
proved real  estate.  Not  only  must  the  owner  charge  rents 
sufficient  to  pay  the  interest  on  the  money  loaned,  he  must  charge 
sufficient  to  provide  funds  necessary  to  operate  tlic  huilding, 
furnishing  elevator  service,  cleaning,  decorating,  and  regiilMr 
repairs,  but  he  must  also  charge  an  amount  to  provide  a  sinking 
fund  that  will  pay  off  the  mortgage  when  due.  It  is  a  mistaken 
idea  in  the  case  of  public  service  utilities,  too  connnonly  known, 
that,  when  the  public  has  paid  operating  expenses  and  a  return 
upon  the  theoretically  depreciated  value  of  the  property,  it  has 
fulfilled  its  full  obhgation  to  the  investor,  whereas  the  latter  is 
entitled  as  a  rule  to  receive  from  the  public  not  only  a  return  on 
the  undepreciated  value  of  his  property  throughout  the  entire 
period  of  its  service,  but,  in  addition,  the  full  value  of  that 
property  which  is  worn-out  and  becomes  worthless  in  the  service 
of  the  public,  in  order  that  both  the  return  upon  the  investment 
and  the  investment  itself  may  be  received  by  the  owner. 

Working  Capital. — The  term  "working  capital"  is  usually 
taken  to  include  that  part  of  the  capital  investment  of  a  Public 
Utility  Corporation  represented  by: 

First. — Necessary  cash  on  hand  and  in  banks. 

Second. — The  value  of  materials,  stores  and  supplies  in  stock 
necessary  for  the  normal  conduct  of  the  business. 

The  above  limited  use  of  the  term  working  capital  does  not 
properly  cover  and  include  all  of  those  quick  assets  which  should 
be  recognized  and  allowed  in  determining  the  fair  value  of  work- 
ing capital  required  by  the  ordinary,  going  utility. 

In  addition  to  the  elements  enumerated  above,  there  should 
be  considered  and  included  accounts  receivable  and  the  accounts 
payable,  as  well  as  the  value  of  other  assets,  such  as  prepayments, 
stocks  on  hand,  or  possibly  even  credits,  by  which  the  conduct 
of  the  business  may  be  facilitated  and  its  cost  minimized. 

In  cases  of  purchase  and  sale,  the  cash  on  hand  or  in  banks  is 
not  ordinarily  transferred  with  title  to  the  property.  On  the 
other  hand,  the  present  value  of  stores  and  supplies,  the  dif- 
ference between  accounts  receivable  and  accounts  payable, 
accrued  interest,  wages,  taxes  and  prepayments,  are  all  usually 
considered  and  equitably  adjusted  in  the  price  paid  by  the 
purchaser. 

It  is  generally  conceded  by  authorities  in  public  service  regu- 
lation that  the  question  with  regard  to  working  capital  is  not 


166  VALUE  FOR  RATE-MAKING 

whether  any  working  capital  should  be  provided  as  a  part  of  the 
capital  cost,  but  rather  the  amount  of  working  capital  to  be 
properly  allowed  in  the  sum  representing  the  total  fair  value  of 
the  property  used  and  useful. 

The  amount  of  working  capital  will  vary  with  the  character 
of  the  business  of  the  corporation  being  considered.  With 
street  railways,  for  example,  where  the  fare  is  paid  by  the  pas- 
senger in  advance  of  the  service  to  be  rendered,  the  amount  of 
cash  working  capital  required  by  such  utility  will  be  very  much 
less  than  in  the  case  of  a  water- works  corporation,  which  sends 
out  bills  only  once  in  three  or  six  months  and  receives  its  payment 
from  four  to  eight  months  after  rendition  of  service. 

The  cash  on  hand  at  any  particular  period,  or  the  average  of 
different  periods,  may  not  fairly  indicate  the  cash  quickly  avail- 
able for  a  utility,  because  other  quick  assets  or  individual  credit 
may  permit  the  drawing  down  of  cash  actually  on  hand  to  a 
minimum.  In  a  similar  way,  the  value  of  stores  and  supplies 
found  to  be  on  hand  at  any  particular  time  may  not  be  a  fair 
indication  of  the  amount  to  be  allowed  for  this  purpose.  In  the 
case  of  any  particular  utility  being  considered,  regard  must  be 
given  as  to  the  distance  from  which  stores  and  supplies  are  prin- 
cipally shipped,  the  time  required  for  filling  orders  by  the  manu- 
facturers after  placing,  the  tardiness  of  transportation,  due  to 
distance  or  congestion;  these  matters  all  bear  on  the  question  of 
proper  allowance  of  the  quantities  and  hence  the  amount  of 
capital  equitably  necessary  for  stores  and  supplies. 

In  determining  the  value  of  a  utility,  whether  for  rate-making 
or  sale,  consideration  of  all  of  the  elements  fairly  constituting 
working  capital  should  be  ascertained  and  included  or  excluded, 
as  the  circumstances  may  warrant.  These  elements  may  fairly 
be  divided  as  follows: 
Current  Assets: 

Cash. 

Stores  and  supplies. 

Manufactured  product  on  hand. 

Manufactured  product  dehvered  to  customers  but  not  billed. 

Accounts  receivable. 

Prepayments  of  insurance,  taxes  or  other  normal  operating  expenses. 
Current  Liabilities: 

Accounts  payable. 

Interest  accrued. 

Wages  accrued. 

Taxes  or  insurance  accrued. 


FRANCHISES,  WORKING  CAPITAL,  DISCOUNTS    ic: 

Criticism  of  the  acceptance,  as  working  capital,  of  the  excess  of 
current  assets  over  current  Kabilities  has  been  made  on  the  jthmumI 
that  such  assets  include  at  certain  times  cash  held  for  invcsttncnt, 
interest,  dividends  or  taxes,  which  would  thereby  artificially  in- 
crease the  real  working  capital.  Of  course,  this  criticism  is  jusf  in 
proportion  to  the  amounts  of  cash  regularly  held  in  the  bank  for 
investment  in  plant  additions  but  such  criticism  further  assumes 
that  interest,  dividends  and  taxes  are  always  wholly  accumulated 
in  cash  before  being  paid  out,  which  is  not  necessarily  a  fact. 
Working  capital  must  be  sufficient  to  provide  funds  for  the  pur- 
chase of  repair  parts  and  maintenance,  as  well  as  all  other  oper- 
ating expenses,  also  such  proportion  of  the  interest,  dividends, 
taxes  and  like  expenses,  which  must  be  paid  regularly,  even 
though  they  may  not  yet  have  been  paid  in,  though  accrued,  and 
in  other  instances  where  there  is  a  temporary  loss  of  revenue  due 
to  financial  embarrassment  or  panic,  strikes  of  labor  or  other 
abnormal  conditions.  Very  frequently  public  utility  corporations 
are  not  able  to  wholly  accumulate  interest  payments  in  advance. 
In  all  considerations  of  the  amount  of  working  capital  to  be 
allowed  any  utility,  liberality  should  be  used,  because  the  public 
is  only  called  upon  to  pay  a  return  on  the  amount  allowed,  and  a 
very  small  difference  in  this  respect  would  make  a  large  difference 
in  the  credit,  standing  and  financial  ability  of  the  utility,  and  in 
most  instances  would  many  times  compensate  the  public  for 
the  small  difference  in  return  it  would  be  called  upon  to  pay 
between  a  niggardly  or  a  liberal  allowance  for  working  capital. 
It  is  generally  recognized  that  the  working  capital  of  a  corpo- 
ration doing  a  small  business  must  be  relatively  large  compared 
with  the  amount  of  working  capital  required  by  a  corporation 
doing  a  large  business,  because  in  the  case  of  the  latter  in- 
equalities in  receipts  and  expenditures  tend  to  equalize  and 
smooth  themselves  out,  due  to  the  very  much  greater  number  of 
transactions. 

In  order  that  a  utility  may  be  enabled  to  carry  on  its  business 
with  the  maximum  economy,  resulting  from  advantageous  buy- 
ing and  discounting  of  bills,  there  must  be  available,  both  the 
highest  credit  and  sufficient  cash  on  hand  to  take  advantage 
of  discounts.  It  may  be  argued  that  it  is  not  necessary  to  pay 
for  supplies  as  soon  as  delivered,  because  30  or  60  days  credit  is 
obtainable.  Again,  it  is  claimed  a  utility  with  reasonable 
credit  may  borrow  from  time  to  time  to  provide  for  current 


168  VALUE  FOR  RATE-MAKING 

needs.  The  answer  to  the  first  argument  is  that  a  discount 
is  usually  obtainable  for  prompt  payment  as  the  seller  must, 
of  necessity,  include  the  interest  charge  in  his  selling  price  if 
compelled  to  carry  an  account  for  30  or  60  or  90  days.  In  reply 
to  the  second  argument,  borrowing  of  course  requires  the  paying 
of  interest  on  loans,  which  results  in  a  higher  operating  cost  to 
the  utility  and  increases  the  rates  for  service  rendered;  conse- 
quently a  fairly  definite  amount  of  cash  on  hand  should  always  be 
held  as  liquid  capital  by  every  properly  managed  efficient  public 
utility. 

To  render  efficient  service  a  utility  must  always  have  on  hand 
and  available  an  ample  quantity  of  stores  and  supplies  with 
which  to  make  repairs  or  replacements  that  are  ordinarily  de- 
manded at  a  fairly  uniform  rate,  but  which  must  be  available  in 
sufficient  quantity  at  all  times  to  provide  for  unexpected  or 
sudden,  unusual  and  exceptional  demands.  In  order  to  manu- 
facture or  provide  the  commodity  which  is  later  sold  to  its 
customers,  the  utility  must  purchase  and  furnish  in  advance 
of  consumption,  sometimes  for  long  periods  previous  to  con- 
sumption, such  items  as  fuel,  oil,  labor,  etc.  Consequently,  in 
addition  to  cash  on  hand  or  in  bank,  there  must  be  always  con- 
veniently available  or  in  storerooms  a  quantity  of  stores,  sup- 
plies, repair  and  renewal  parts,  as  well  as  fuel,  oil  or  other  raw 
material  required  by  the  manufacturing  processes  that  repre- 
sent a  proportion  of  the  capital  investment  of  a  properly  managed 
public  utility. 

In  addition  to  stores  and  supplies  on  hand,  the  value  of  product 
manufactured  or  delivered,  but  not  yet  billed,  such  as  gas  in  a 
holder  or  electrical  energy  delivered  to  consumers  in  advance 
of  the  monthly  billing,  may  fairly  be  included.  The  value  of 
these  products,  which  often  represent  a  substantial  part  of  the 
capital  of  a  utility  tied  up  and  invested  in  the  business,  has 
frequently  been  overlooked  or  ignored  in  fixing  the  proper  basis 
for  rate-making.  It  will  be  recognized  that  the  books  do  not 
show  the  value  of  such  product  as  has  been  manufactured,  or 
possibly  sold  and  delivered,  until  the  bills  against  the  consumers 
are  made  out,  although  the  cost  of  manufacture  has  accrued 
against  the  company.  Where  bills  are  made  out  at  frequent 
intervals  the  value  of  the  product  may  not  run  into  very  large 
amounts,  but  where  bills  are  rendered  semi-annually,  for  example 
in  the  case  of  water-works,  the  value  of  the  manufactured  or 


FRANCHISES,  WORKING  CAPITAL,  DISC()(J\TS    \m 

delivered  product  may  prove  to  be  a  very  coiisidcraMc  portion 
of  the  total  value  of  the  property. 

Under  the  generally  accepted  terms  and  methods  of  doinj^ 
business,  goods  and  materials  received  are  not  paid  for  upon 
delivery,  with  the  result  that  bills  and  accounts  receivable  and 
bills  and  accounts  payable  largely  tend  to  offset  one  another,  but 
their  difference  either  as  a  credit  or  debit  may  be  taken  into 
account  in  ascertaining  the  proper  and  necessary  working  capital 
of  utility. 

It  is  frequently  the  case  that  the  control  of  a  public  utility  is 
held  by  a  holding  or  controlling  company  through  stock  owner- 
ship. In  such  cases  it  is  not  uncommon  practice  for  the  holding 
company  to  have  turned  over  to  it  at  frequent  intervals,  perhaps 
monthly,  practically  all  revenues  received  by  the  subsidiary 
corporation,  then  all  bills  for  supplies,  equipment,  salaries, 
interest  and  other  large  items  are  paid  by  the  holding  company, 
the  subsidiary  corporations  merely  keeping  small  amounts  of 
cash  on  hand  with  which  to  pay  local,  current  bills.  Under  these 
conditions  the  holding  company,  and  not  the  local  corporations, 
as  a  matter  of  fact,  requires  the  bulk  of  the  working  capital 
necessary  to  conduct  the  operations  of  the  subsidiary  cor- 
porations; hence  the  quick  assets  and  cash  on  hand  of  the 
latter  do  not  indicate  the  amounts  required  for  the  proper 
conduct  of  their  business,  because  in  such  cases  the  cash,  quick 
assets  and  credit  of  the  holding  company  are  used  for  the  benefit 
of  the  subsidiary  companies.  In  determining  the  proper  amount 
of  working  capital  that  should  be  allowed  a  subsidiary  company, 
controlled  in  the  manner  indicated,  this  credit  of  the  suV)sidiary 
company  with  the  holding  company  is  usually  equivalent  in 
value  to  quick  assets  or  cash  actually  on  hand.  This  arrange- 
ment and  credit  of  the  subsidiary  company  with  the  holding 
company,  together  with  the  cash  or  other  quick  assets  held  locally 
by  the  former,  the  value  of  the  stores  and  supplies  on  hand, 
both  locally  and  at  the  distributing  center,  controlled  by  the 
holding  company  and  held  available  for  the  benefit  of  the 
subsidiary  company,  together  constitute  the  working  capital  of 
the  subsidiary  company.  A  fair  method  of  ascertaining  the 
total  value  of  the  stores  and  supplies,  cash  on  hand  and  quick 
assets  that  may  normally  be  allowed  the  subsidiary  company, 
existing  under  such  arrangements  and  controlled  as  outlined 
above,  may  be  measured  by  the  methods  suggested  as  proper 


170  VALUE  FOR  RATE-MAKING 

for  determining  the  working  capital  of  a  utility  entirely  locally 
controlled. 

Various  methods  have  been  suggested  for  determining  the 
proper  amount  of  working  capital  required  for  the  different  classes 
of  utilities  under  normal  or  average  conditions.  A  very  generally 
accepted  basis  of  estimate  is  to  fix  the  amount  of  cash  working 
capital  from  a  consideration  of  the  annual  gross  revenues.  This 
basis  has  been  frequently  accepted  by  courts  and  commissions  as 
reasonable,  because  related  to  the  amount  of  business  being 
transacted  and  dependent,  in  a  large  measure,  upon  those  re- 
ceipts and  their  usually  attendant  expenses.  Varying  percentages 
of  the  annual  gross  revenue  have  been  used  for  determining  cash 
working  capital,  varying  from  5  per  cent,  to  25  per  cent,  depend- 
ing upon  the  character  of  the  business  and  the  size  and  credit  of 
the  corporation.  An  examination  of  the  cash  balances  kept  on 
hand  by  a  number  of  public  utilities  of  different  classes,  such  as 
gas,  electric  light  and  street  railway  property,  averaged  over  a 
large  number  of  months,  aggregating  several  years,  shows  that 
practically  121^  per  cent,  of  gross  revenue  was  maintained  as 
the  actual  cash  working  capital  on  hand.  This  figure  would, 
therefore,  seem  to  have  considerable  weight  as  showing  the  normal 
average  condition  and  the  average  requirements  of  such  utility. 

A  second  method  of  determining  the  normal  amount  of  cash 
working  capital  required  by  a  public  utility,  which  is  receiving 
much  consideration,  is  based  on  an  examination  of  the  monthly 
and  annual  operating  expenses  and  payments,  as  well  as  the  con- 
ditions under  which  receipts  from  the  sale  of  the  service  rendered 
by  the  utility,  are  received  from  its  customers,  by  the  corporation. 
It  will  be  seen  where  receipts  do  not  come  in  for  15  days,  for  ex- 
ample, after  the  expiration  of  the  period  to  which  such  receipts 
relate,  and  the  bills  upon  which  such  receipts  are  based  are 
rendered  the  first  of  the  month  for  service  performed  during 
the  preceding  month,  the  current  liabilities  of  the  corporation 
being  largely  incurred  before  the  service  is  rendered,  the  payment 
of  which  liabilities  under  the  wisest  business  management  should 
not  and  cannot  be  deferred,  there  probably  should  be  provided 
and  available  sufficient  cash  working  capital  to  meet  two  months' 
average  payments.  When  bills  are  not  rendered  monthly  but 
over  longer  periods,  still  larger  amounts  of  cash  working  capital 
must  be  provided  than  would  be  indicated  by  a  two  months'  aver- 
ago  payment  of  expenses.     Moreover,  an  amount  larger  than  that 


FRANCHISES,  WORKING  CAPITAL,   DISCOUNTS    171 


Table  V. — Woukin*;  ('aimt.m, 
Public  Service  Commission  Decision,  Working  (',i])it:il  Ailowanct^ 


i 
Revenue    Op.  exps. 

1 

Net 

Repro.  val. 

i 
Working  cap. 

■    Per  r< 
Rev. 

III.  of 

1  val. 

Wisconsin  : 

Madison  G      /  G 
&  E   Co.          IE 

Beloit   W.   G.   & 

$ 

141,272 
199,892 

181,f)61 

1    

1 
« 

82,615 
100,293 

97,435 

$ 
58,6.57 
99,599 

83,120 

412,000 
535,000 

(45  ,"i0,000; 

(suppl. 

$.30,000) 

45-45,000 

('/^  cash-?i 

suppl.) 

914,948 
(484,578  cash) 

854,2.^.2 
1  766,008 

40,000 

(half  cash 

and  half 

suppl  ) 

80.000 

(half  cash 

and  half 

suppl.) 

.30,000 

45,000 

45,032 

100,000 

Cash    100,000 
M.&S.  5 1,037 
Cash      80,0(X) 
M.&S.  40, 180 
Cash      60,000 
M.&S.  30,000 

255,000 

(stores  and 

cash) 

;  15 

23  5 

17!) 
12.5 

}  12.6 
1  7.95 
}    8.5 

40  0 

5.8 

Elec.  Co. 

St.  Louis  Com.: 
Union  E.  L.  J  G 

16,976,025 

26,417,414 
1,130,470 

2,477,579 

1,082,813 
993,867 

1,130,000 

7,378,020 

3,194,159 
2,768,785 
2,614,363 

4,700,000 

&  Pr.  Co.        1  E 
Maryland  Com. : 
Consolidated  [ 

G.   E.   L.  &  ^  ^ 

P.  Co.             i^ 
New  York: 

Bklyn.  Boro.  O. 

Co. 

KingsCo.  Lt.  Co. 

Queensboro    f  G 
G.  &  Elec.    ]  E 

I 

1 

5.38 
6  1 

.1   5 

3.24 

2  77 

J 

224,931 

042,040 

148,365 
(including 

$26,364 
amortiza.) 

349,792 

77,170 
289,645 

4   55 

Co.                  ^ 
Bronx     Gas     & 



4    1' 

Electric  Co. 
Rochester  Corn- 

1   36 

ing  Elmira  Tr. 

Co. 
Buffalo         Gen. 

Elec.  Co. 
Cataract    Pr.  & 

Conduit  Co. 
Federal    Tel.    & 

Telg.  Co. 
Washington : 
Pacific  Pr.  &  Lt. 

Co. 

1,204,006 
1.516,100 
1,057,807 

6.53,651 

681,485 

1,1.53,000 

545,419 

286,718 

522.. 521 

512,388 
366,932 

4.75 
4.35 
3.45 

5   44 

CODRT   DeCISI 

oNs,  Working  Ca 

PITAL  AlLO 

WANCl 

:s 

Consolidated 
Gas  Co. 

$ 
13,552,482 

$ 
9,936,910 

3,015,572 

$ 

55,612,435 

4,750,000     1 
12,179,217 

«                          1 
1,616,000 

(610,000 

suppl.) 

250,000 

(cash  and 

suppl.) 

662,118 

(cash  400.2851 

suppl. 261,833, 

119 

1 

]20.9 

2.9 
5.7 

Third  Ave.  Rail- 
road 

3,164,582 

1,704,477 

1,460,105 

5.44 

172  VALUE  FOR  RATE-MAKING 

required  to  meet  normal  average  conditions  must  be  allowed  to 
provide  for  the  contingent,  unexpected  and  abnormal  condition 
caused  by  strikes,  financial  stringencies,  fire,  accident  or  other 
unusual  events,  which  prevent  the  normal  receipt  of  revenue  or 
call  for  more  than  normal  expenditures. 

A  third  basis  of  ascertaining  normal  working  capital  to  be 
allowed  any  particular  corporation  is  by  fixing  a  ratio  of  that 
capital  to  the  appraised  value  of  the  property.  A  consideration 
of  the  decisions  of  public  service  commissions  and  courts  indicates 
that  the  sum  of  working  capital  allowed  to  cover  stores  and 
supplies  and  cash,  together  with  quick  assets,  varies  from  3  to  6 
or  7  per  cent,  of  the  appraised  value  of  the  property;  the  stores 
and  supplies  frequently  being  about  twice  the  amount  of  cash 
or  cash  assets.  As  explained  above,  the  amount  will,  of  course, 
vary  with  the  character  of  the  utility  being  considered  and  the 
practice  that  exists  as  to  the  frequency  of  rendering  bills  for 
service  rendered  and  the  promptness  of  payment  of  the  users. 
From  an  examination  of  the  decisions  of  commissions  and  courts, 
the  foregoing  table,  showing  typical  allowances  made  for  working 
capital,  has  been  prepared: 

Bond  Discount. — There  are  conflicting  opinions  and  rulings 
as  to  whether  or  not  the  amount  of  discount,  that  is,  the  differ- 
ence between  the  selling  price  and  the  par  value  of  bonds,  should 
be  included  as  a  part  of  the  property  upon  which  rates  are  fixed. 

It  is  generally  conceded  that  the  bonds  issued  by  most  public 
utilities  must  be  sold  for  something  less  than  par.  The  amount 
of  discount  necessary  to  effect  the  sale  of  any  particular  bonds, 
will  depend  primarily  upon: 

(a)  The  rate  of  interest. 

{b)  The  ratio  of  the  total  bond  issue  to  the  total  value  of  the  property. 

(c)  The  class  of  property  given  as  security  for  the  bonds. 

(d)  The  ratio  of  interest  charges  to  total  net  revenue. 

Under  varying  conditions  of  the  money  market  and  changes 
in  public  opinion,  whether  warranted  by  existing  circumstances 
or  the  result  merely  of  misinformation  or  prejudice,  the  amount  of 
discount  at  which  bonds  must  be  sold  varies,  regardless  of  the 
four  primary  conditions  above  mentioned. 

Despite  mathematical  calculations  and  the  contention  of 
certain  theorists  with  regard  to  the  matter,  bonds  cannot  be 
sold  upon  a  uniform  basis  of  return  regardless  of  the  rate  of 
interest,  that  is,  a  5  per  cent,  bond  will  bring  a  better  price 


FRANCHISES,  WORKING  CAPITAL,  DISCOCXTS    \7A 

relatively  than  a  6  per  cent,  bond  issued  by  the  same  utility, 
on  the  same  property,  under  the  same  conditions.  For  example, 
a  5  per  cent.,  20-year  bond  might  sell  at  83>^  netting  the  investor 
6  per  cent,  upon  his  money.  If  the  same  issue  of  bonds  were 
made  to  bear  6  per  cent,  rate  of  interest,  all  other  conditions 
remaining  the  same,  they  probably  could  not  be  sold  at  par  in 
the  market.  Despite  the  seeming  inconsistency,  such  con- 
ditions exist  by  reason  of  opinions  or  prejudices  of  investors, 
which  must  be  recognized,  admitted  and  consented  to  in  dealing 
with  bond  discounts. 

Whether  or  not  bond  discount  is  to  be  allowed  as  a  part  of 
the  value  of  property,  will  depend  upon  the  method  followed 
in  determining  the  value  of  such  property.  If,  in  addition  to 
the  value  of  the  physical  property,  with  its  intangible  elements, 
there  has  been  included  an  amount  to  properly  cover  the  cost 
of  financing  and  other  expenses  incidental  to  raising  capital, 
then  there  is  no  reason  for  including  in  the  total  value  of  the 
property  any  amount  to  cover  bond  discount.  On  the  other 
hand,  if  bond  discount  is  considered  a  part  of  the  cost  of  financing, 
which  necessary  and  essential  element  of  value  has  not  l)ccii 
taken  into  account  and  allowed  for  in  the  total  value  of  the 
property,  then  the  amount  of  bond  discount  should  be  included 
with  the  other  costs  of  the  property.  This  latter  view  is  that 
uniformly  taken  by  the  Railroad  Commission  of  Wisconsin, 
which,  both  in  condemnation  and  rate  cases,  seems  to  look 
upon  bond  discount  as  the  cost  of  financing. 

"It  is  difficult  to  say  on  what  grounds  such  discounts  (on  bonds) 
should  not  be  included  in  the  cost  of  the  plant.  To  so  include  it,  lias 
been  and  is  the  almost  universal  practice."^ 

Other  commissions  and  courts  have  recognized  the  justice 
and  fairness  of  such  allowance  as  has  been  shown  at  some  length 
elsewhere.^ 

In  many  cases  bond  discount  does  not  wholly  represent  the 
cost  of  financing;  for  example,  the  bonds  may  sell  at  20  points 
below  their  par  value,  whereas  the  actual  cost  of  financing  may  i)e 
only  5  points,  leaving  15  points  as  profit  to  the  purchaser  of  the 
bonds  (assuming  that  he  eventually  realizes  par)  which  profit 
is  a  part  of  the  reward  for  consenting  to  accept  the  low  rate  ot 

1  Hill  vs.  Antigo  Water  Company,  2.  W.  R.  C.  R.  627. 

2  "Valuation  of  Public  Utility  Properties,"  Henry  Floy,  page  118. 


174  VALUE  FOR  RATE-MAKING 

interest  borne  by  the  bonds.  Such  profits  of  the  bond  buyer 
must  be  eventually  paid  out  of  the  fair  return  allowed  on  the 
property:  it  should  not  be  charged  to  the  public  as  an  additional 
expense  of  rendering  service,  provided — and  only  in  such  case — 
said  expense  has  already  been  made  to  include  a  fair  return  on  the 
fair  value  of  the  property  which  value,  as  determined,  covers 
all  costs  of  financing. 

Bond  discount,  in  reality,  is  only  a  method  of  financing,  in 
which  the  public  may  not  be  directly  interested.  If  the  pro- 
moters and  owners  of  a  utility  enterprise  are  allowed  such  fair  rate 
of  return  as  to  cover  all  reward  due  them  for  making  an  invest- 
ment under  the  risks  of  such  business,  then  that  total  return  to 
them  should  provide  all  interest  and  profits,  regardless  of  the 
principle  or  method  of  financing  that  may  be  followed.  To  illus- 
trate: if  a  utility  enterprise  requires  $100,000  investment  includ- 
ing all  property  costs,  covering  in  addition  to  the  outlay  for  phys- 
ical property,  the  cost  of  developing  the  business,  reward  for 
promoters'  services  and  expenses,  cost  of  financing,  and  all  like 
elements,  and  if  9  per  cent,  is  considered  a  fair  return  above  all 
operating  expenses  upon  the  investment,  then  $9,000  per  annum 
should  be  allowed  the  owners  as  their  total  return.  If  the 
owners,  instead  of  providing  all  of  the  $100,000  required,  prefer 
to  issue  $75,000  of  20-year  bonds,  selling  them  at  20  per  cent. dis- 
count so  as  to  furnish  $60,000  of  cash,  leaving  only  $40,000  cash 
to  be  provided  by  them,  they,  in  fairness,  should  provide  out  of 
the  9,000  actually  allowed  them  as  the  total  reward,  such  amount 
as  is  necessary  to  amortize  the  discount  on  the  bonds.  Other- 
wise, the  public  would  be  twice  paying  for  the  same  thing.  The 
owners,  in  issuing  $75,000  par  value  of  bonds,  would  perhaps 
put  them  out,  bearing  5  per  cent,  rate  of  interest,  so  that  without 
taking  into  account  the  discount  of  bonds,  they  would  only  have 
to  pay  $3,750  annual  interest,  whereas  they  would  be  allowed  earn- 
ings of  $5,400  per  annum  on  the  $60,000  invested.  Now  if  the 
owners  were  not  compelled  to  amortize  the  discount  on  the  bonds, 
they  would  thereby  make  an  annual  profit  of  $1,650  in  addition 
to  $3,600,  the  9  per  cent,  which  we  have  assumed  is  the  fair  rate 
of  return  upon  the  money  they  actually  invested,  namely,  $40,000. 
Upon  a  4  per  cent,  sinking  fund  basis  covering  a  20-year  period, 
the  assumed  life  of  the  bonds,  there  would  be  required  $504  per 
annum  to  take  care  of  the  bond  discount.  This  added  to  the 
assumed  interest  on  the  bonds,  $3,750,  makes  a  total  of  $4,254,  out 


FRANCHISES,  WORKING  CAPITA!.,  DfSCOl^XTS    I?:, 

of  the  $5,400  per  annum  allowed  Iheni,  which  it  would  properly 
cost  the  owners  for  the  $00,000  raised  through  the  sale  of  bonds. 
The  difference,  $1,146,  equitably  belongs  to  the  owners  for  the 
additional  risk  they  assume  in  practically  guaranteeing  a  bond 
issue  equal  to  75  per  cent,  of  the  value  of  the  property,  and  taking 
the  additional  risk  of  having  their  investment,  amounting  to  40 
per  cent,  of  the  total,  merely  a  second  lien  upon  the  property. 
In  the  same  way,  other  illustrations  could  be  given,  which,  l)y 
reducing  the  amount  of  the  bond  issue,  would  increase  the  amount 
of  money  to  be  provided  by  the  owners,  and  at  the  same  time 
very  properly  reduce  their  rate  of  return  above  the  9  per  cent, 
allowed,  as  their  risk  is  less,  by  reason  of  the  fact  that  they  now 
represent  a  larger  proportion  of  the  total  investment  in  the 
property. 

In  the  above  discussion  it  is  to  be  held  clearly  in  mind  that  bond 
discount,  where  not  taken  into  consideration  in  fixing  the  value 
of  the  property,  must  be  offset  and  compensated  for  by  including 
all  financial  costs  fairly  to  be  included  as  one  of  the  elements  of 
property  valuation,  such  as  commissions  to  a  bond  and  brokerage 
house  on  the  sale  of  securities,  cost  of  advertising,  printing,  legal 
and  trust  company  charges,  and  other  necessary  expenses  of 
similar  character.  Moreover,  when  bond  discount  is  excluded 
from  property  value,  all  of  those  proper  expenses,  such  as  bonuses, 
stock  given  away  or  sold  at  a  discount  or  other  concessions,  fairly 
evaluated,  that  may  have  to  be  granted  in  connection  with  th(; 
raising  of  money  for  a  utility  enterprise,  must  be  included  as  u 
part  of  the  property  value. 

As  intimated  elsewhere,  public  authorities  too  frequently  con- 
sider bond  interest  practically  equivalent  to  fair  return,  and  in 
such  cases  of  erroneous  procedure,  bond  discount  may  properly 
be  included  in  property  value  as  part  of  the  "initial  cost"  of 
borrowed  money,  that  is,  the  cost  for  its  use  over  and  above  the 
actual  cost  represented  by  the  nominal  or  coupon  rate  of  interest. 
The  rate  of  interest  and  the  discount  of  the  bonds  are  closely 
related,  and  together  form  the  cost  of  borrowed  money,  so  that 
the  rate  of  interest  on  the  bonds,  without  consideration  of  the 
discount,  does  not  fix  the  cost  of  money. 

Practically  it  is  not  always  possible  to  segregate  bond  discount 
into  its  component  parts,  namely,  the  cost  of  the  borrowed  money 
itself  if  it  could  be  obtained  without  expense  and  the  brokerage 
or  expense  of  obtaining  the  same.     Recently  there  has  been  a 


176  VALUE  FOR  RATE-MAKING 

wider  recognition  of  the  various  elements  going  to  make  up  bond 
discount,  and  an  earnest  attempt  to  support  these  elements  and 
properly  allot  them. 

In  some  instances,  bond  discount  partly  represents  interest 
during  construction,  and  in  that  case  is  a  proper  charge  against 
the  property  account.  In  the  present-day  desire  to  have  the 
value  of  the  property  correspond  with  the  value  of  the  physical 
property,  current  practice  tends  to  prescribe  that  bond  discount 
be  amortized  from  income,  in  order  to  extinguish  such  discount 
as  a  capital  asset. 


CHAPTER  VITI 
GOING  VALUE 

Going  Value  must  be  Allowed. — The  term,  goinp;  value,  may 
properly  be  taken  to  mean  a  value  attaching  to  a  pubUc  utiUty 
property  as  the  result  of  its  having  an  established  revenue-pro- 
ducing business.  The  total  fair  value  of  any  utility  property 
aside  from  franchise  value,  may  be  said,  broadly,  to  consist  of  the 
sum  of  at  least  two  quite  distinct  values,  one,  represented  by  the 
physical  property  including  all  of  those  preliminary  and  overhead 
costs  necessary  to  prepare  the  plant  to  render  service,  the  other 
the  non-physical  but  equally  important  costs  to  be  met  in  creating 
the  business  and  revenue. 

Going  value  may  be  determined  from  a  consideration  of  the 
amounts  of  money  actually  expended  in  the  cost  of  producing  the 
business,  the  same  as  the  value  of  physical  property  may  be 
arrived  at  from  a  consideration  of  the  original  cost  thereof. 
On  the  other  hand,  going  value  may  be  determined  from  con- 
sideration of  the  present  cost  of  reproducing  the  present  revenue, 
just  as  the  value  of  the  physical  property  is  determined  from  the 
cost  of  reproducing  that  property  at  present-day  prices.  In 
view  of  the  fact  that  the  cost  of  reproduction  is  coming  to  be 
accepted  as  the  more  generally  applicable  and  accurately  de- 
termined basis  of  value  in  existing  properties,  to  be  consistent, 
going  value,  determined  upon  the  basis  of  reproduction  rath(T 
than  upon  original  cost,  should  logically  become  the  most 
generally  used  basis  for  determining  this  element. 

Going  value  is  not  in  any  sense  "good  will,"  which  latter  courts 
and  commissions  now  unanimously  agree  has  no  place  m  the 
valuation  of  a  utility  property  that  is  a  monopoly.  Neither  does 
going  value  include  franchise  value,  which,  under  the  court  and 
commission  decisions  thus  far  rendered,  is  frequently  hold  to  be 
no  more  valuable  than  the  actual  legitimate  expenditure  made  m 
securing  the  franchise,  in  the  way  of  costs  of  perfecting  title  or 
payments  to  public  authorities. 
12  177 


178  VALUE  FOR  RATE-MAKING 

Until  comparatively  recently,  it  has  been  strongly  argued  that 
the  fair  value  of  public  utility  property  should  not  include  any- 
thing for  going  value.  But  the  overwhelming  weight  of  recent 
court  decisions  holds  clearly  that  going  value  is  properly  a  part 
of  property  value  and  must  be  recognized  and  allowed. 

The  recent  decision  of  the  Supreme  Court  of  New  Jersey  upheld 
the  very  large  allowance  made  by  the  Public  Utility  Com- 
missioners of  New  Jersey  in  ascertaining  the  value  of  the  property 
of  the  Gas  Company  upon  which  gas  rates  were  fixed  in  the  so- 
called  Passaic  case.  The  Commission  had  allowed  $1,025,000, 
namely,  30  per  cent,  of  the  value  of  the  structural  property,  for 
going  value;  the  cities  affected  claimed  that  no  allowance  should 
be  made  for  this  item,  but  the  Court  said: 

"It  is  necessary,  therefore,  to  determine  first  whether  any  allowance 
at  all  for  going  value  is  proper.  We  think  both  on  weight  of  authority 
and  on  reason  there  should  be  such  an  allowance. 

"The  legal  question  is  whether  these  items  constitute  a  going  value 
upon  which  the  company  is  entitled  to  a  return  if  the  individual  rate  is 
to  be  just  and  reasonable.  To  this  we  answer,  yes.  The  argument 
addressed  to  us  on  the  other  side  is  that  all  the  so-called  going  value 
appears  in  the  valuation  of  the  physical  plant  at  the  cost  of  reproduction; 
the  suggestion  is  that  unless  there  was  going  value  the  physical  plant 
would  be  a  mere  junk,  and  that  the  difference  between  the  valuation  as 
junk  is  the  true  going  value.  The  argument  seems  to  us  specious 
rather  than  sound.  We  think  that  if  by  value  we  mean  what 
the  economists  call  exchange  value,  then  a  buyer  would  undoubt- 
edly give  more  for  a  plant  already  doing  a  profitable  business  than  for  a 
plant  of  equal  cost,  capacity,  and  future  possibilities,  but  without  the 
established  business.  To  a  purchaser  the  assurance  of  an  immediate 
return  is  worth  paying  for,  and  we  see  no  reason  to  doubt  the  correctness 
of  the  ruling  of  the  United  States  Supreme  Court  in  Omaha  vs.  Omaha 
Water  Co.,  218  U.  S.  180.  *  *  *  It  is  true  that  that  was  a  condemna- 
tion case  and  not  a  rate  case,  and  involved,  therefore,  a  question  of 
exchange  value,  and  not  the  question  of  a  fair  and  reasonable  valuation 
as  between  a  public  service  company  and  the  pubhc.  The  two  l)ases  of 
valuation  may  properly  be  different,  since  upon  a  sale  or  condemnation 
the  probability  of  an  assured  income  and  a  continuance  of  the  existing 
rates  enters  into  and  affects  the  exchange  value;  while  in  the  case  of  a 
valuation  for  the  purpose  of  fixing  a  rate,  the  question  is  what  value  and 
rate  will  tempt  the  investment  of  capital,  and  to  what  extent  existing 
rates  may  with  justice  be  lowered.  In  this  view  the  fallacy  of  the  argu- 
ment on  behalf  of  the  cities  is  that  it  requires  the  investor  to  suffer  all 


GOING  VALUE  179 

the  loss  if  the  enterprise  fails,  cand  deprives  him  of  the  chance  of  addi- 
tional gain  if  the  enterprise  succeeds;  and  it  fails  to  allow  any  recompense 
for  the  skill  shown  in  developing  and  conducting  the  business  or  even 
for  the  value  of  experience,  which  is  proverbially  expensive."' 

Among  other  explicit  court  opinions,  as  to  the  reasonableness  of 
and  necessity  for  recognition  of  going  value,  the  following  may  tic 
quoted : 

"The  receiver  of  a  water  company  furnishing  water  to  a  city  for  fire 
purposes  without  contract  as  to  price  is  entitled  to  recover,  as  a  fair 
CMnpensation  for  the  service,  a  just  proportion  of  the  operating  expenses, 
taxes,  and  cost  of  administration  paid  by  the  company,  and  of  a  just 
and  reasonable  return  on  the  cost  of  reproducing  its  plant  and  its  going 
value."'* 

"In  consideration  of  the  fact  that  the  system  is  a  going  concern,  the 
appraisers  should  consider,  among  other  things,  the  present  efficiency  of 
the  system,  the  length  of  time  necessary  to  construct  the  same  de  novo, 
the  time  and  cost  needed  after  construction  to  develop  such  new  system 
to  the  level  of  the  present  one  in  respect  to  business  and  income,  and 
the  added  net  income  and  profits,  if  any,  which  by  its  acquirement  as 
such  going  concern,  would  accrue  to  a  purchaser  during  the  time  re- 
quired for  such  new  construction,  and  for  such  development  of  business 
and  income."^ 

"In  ascertaining  the  present  value  of  said  plant,  for  the  purpose  of 
fixing  rates  that  shall  be  charged  for  services  thereon,  the  Corporation 
Commission  should  not  confine  its  consideration  to  their  valuation  of 
the  bare  physical  plant,  where  such  exchange  has  a  large  patronage 
sufficient  to  pay  operating  expenses,  fixed  charges,  and  some  profits, 
when  such  patronage  has  been  built  up  by  expenditures  of  laljor  and 
money  for  a  period  of  time  during  which  the  plant  was  operated  at  a 
loss;  but  these  facts  should  be  considered,  and  a  reasonable  amount 
allowed  for  its  earning  capacity  as  a  going  concern."' 

"Thus  the  first  question  certified  required  us  to  decide  whether 
'going  value'  is  to  be  appraised  as  a  distinct  item,  or  whether  it  is  suffi- 
cient to  regard  it  as  something  vague  and  indefinable  to  be  given  some 
consideration  but  not  enough  to  be  estimated.     The  valuation  of  the 

1  Public  Service  Gas  Company  vs.  Board  of  Public  Utility  Commissioners.  S7  .\tlanfir 
657. 

^  Venner  vs.  Urbana  Water  Co.,  174  Fed.  348,  the  2nd. 

^  Kennebec  Water  EHstrict  vs.  Watersville,  97  Me.  185.  ^ 

«  Pioneer  Telephone  &  Telegraph  vs.  Westenhaver,  29  Okla.  429,  34  L.  R.  A.  N.  t-  IJm. 


180  VALUE  FOR  RATE-MAKING 

physical  property  was  determined  by  ascertaining  the  cost  of  reproduc- 
tion less  accrued  depreciation.  Preliminary  and  development  expense 
prior  to  operation  were  included,  but  no  allowance  was  made  for  the 
cost  of  developing  the  business.  By  that  method,  the  plant  was  valued 
in  a  sense  as  a  'going  concern/  in  other  words,  'scrap'  values  were  not 
taken;  but  to  say  that  that  sufficiently  allows  for  'going  value'  is  the 
same  as  to  say  that  'going  value '  is  not  to  be  taken  into  account.  *  *  * 
It  (the  company)  would  have  been  entitled  to  a  return  on  the  valuation 
adopted  by  the  Commission,  if  it  had  no  customers,  but  was  just  ready 
to  begin  business,  whereas  it  had  a  plant  in  operation  with  an  established 
business,  which  everyone  knows  takes  time,  labor  and  money  to  build 

"It  may  be  conceded  that  going  value  has  no  existence  apart  from 
tangible  property  and  that  commercially  there  is  but  one  value,  that 
of  the  property  as  a  whole,  but  as  the  rate  cannot  be  made  to  depend  up- 
on the  exchange  values,  which  would  in  turn  depend  upon  the  rate,  it 
would  seem  to  be  necessary  to  appraise  the  physical  property  and  the 
going  value  separately,  and  of  course  that  is  the  case  if  the  cost  of  repro- 
duction rule  be  adopted."' 

"  The  decision  of  the  Supreme  Court  in  the  Cedar  Rapids  Gas 
Light  Company  case  is  so  frequently  and  vehemently  used  to 
prove  that  this  Court  does  not  recognize  or  allow  going  value,  it 
seems  worth  while  to  go  into  the  details  of  this  case  and  show 
therefrom  that  the  Supreme  Court  actually  does  recognize  going 
value  as  an  element  of  value  instead  of  excluding  it. 

"  The  opinion  in  the  Cedar  Rapids  case  decides: 

1.  That  because  constitutional  questions  not  frivolous  appear 
upon  the  record  the  motion  to  dismiss  the  appeal  should  be  over- 
ruled. 

2.  That  there  was  no  contract  on  the  part  of  the  city  that  the 
price  should  be  kept  high  enough  to  allow  a  discount  for  prompt 
payment. 

3.  That  the  facts  were  not  open  to  reexamination  except  as 
such  reexamination  might  be  incidental  to  the  questions  raised 
by  the  assignments  of  error. 

4.  That  it  was  not  such  a  clear  case  as  to  warrant  the  reversal 
of  a  decree  which,  though  final  in  form,  merely  postponed  a  deci- 
sion upon  the  merits. 

'  The  People  ex  rel.  Kings  County  Lighting  Co.  vs.  Wilcox  et  al.  Composing  Public 
Service  Commission,  First  District,  State  of  New  York,  Court  of  Appeals;  decision  rendered 
Apr.  24,  1914,  210  N.  Y.  479. 


GOING  VALUE  181 

"  As  supporting  the  conclusion  that  the  case  did  not  require  its 
interference,  the  Court  said : 

'To  refer  in  the  first  instance  to  the  point  just  mentioned,  wo  cannot 
say  as  matter  of  law  that  at  90  cts.  a  thousand  cubic  feet  that  ccjinpany 
will  be  unable  to  collect  payment  without  losses  that  will  amount  to  a 
taking  of  its  property.  Then,  again,  although  it  is  argued  that  the 
Court  excluded  going  value;  the  Court  expressly  took  into  account  the 
fact  that  the  plant  was  in  successful  operation.  What  it  excluded  was 
the  good  will  or  advantage  incidental  to  the  possession  of  a  monopoly, 
so  far  as  that  might  be  supposed  to  give  the  plaintitT  the  power  to 
charge  more  than  a  reasonable  price. '^ 

"  If  we  construe  this  correctly,  it  means  that  this  case  is  not  so 
clear  as  to  justify  interference  because  in  the  first  place  the  Court 
could  not  say  as  a  matter  of  law  that  90  cts.  was  confiscatory;  in 
the  second  place,  while  it  is  claimed  that  the  Court  excluded 
going  value,  the  Court  in  fact  took  into  account  this  factor;  what 
it  excluded  was  good  will  which  was  properly  excluded  upon  the 
authority  of  the  Consolidated  case. 

"To  clearly  apprehend  what  the  Supreme  Court  decided,  it  is 
necessary  to  go  to  the  opinion  of  the  Supreme  Court  of  Iowa. 
That  Court  said  (144  Iowa  434)  with  reference  to  going  value: 

'Also  the  sum  of  $100,000  was  included  by  these  witnesses  as  enhance- 
ment of  value  by  reason  of  being  a  'going  concern.'  As  previously 
intimated,  the  value  of  the  plant  is  to  be  estimated  in  its  entirety,  rather 
than  by  the  addition  of  estimates  on  its  component  parts,  though  the 
latter  course  will  materially  aid  in  determining  the  value.  Advantages 
have  accrued  through  the  sagacity  of  its  management  as  contended 
by  appellant.  So,  too,  there  are  the  inevitable  mistakes  which  would 
not  be  likely  in  the  construction  of  a  new  plant;  but  to  put  a  new  plant 
in  profitable  operation,  time  would  be  required,  and,  aside  from  the 
intangible  element  of  good  will,  the  fact  that  the  plant  is  in  successful 
operation  constitutes  an  element  of  value. 

'As  said,  the  value  of  the  system  as  completed,  earning  a  present 
income,  is  the  criterion.  Insofar  as  influenced  by  income,  however,  the 
computation  necessarily  must  be  made  on  the  basis  of  reasonable 
charges,  for  whatever  is  exacted  for  a  pubhc  service  in  excess  of  this  is 
to  be  regarded  as  unlawful. 

'Save  as  above  indicated,  the  element  of  value  designated  a  'going 
concern'  is  but  another  name  for  'good  will/  which  is  not  to  be  taken 

1  Cedar  Rapids  Gas  Light  Co.  vs.  Cedar  Rapids,  223  U.  S.  669. 


182  VALUE  FOR  RATE-MAKING 

into  account  in  a  case  like  this,  where  the  company  is  granted  a  mo- 
nopoly. Cedar  Rapids  Water  Co.  vs.  City  of  Cedar  Rapids,  118  Iowa 
234;  Wilcox  vs.  Consolidated  Gas  Co.,  29  Sup.  Ct.  192.  The  witnesses 
for  plaintiff  took  into  account  '  good  will '  in  giving  their  opinion  of  the 
enhancement  in  value  because  of  being  a  going  concern,  and  we  have 
no  means  of  separating  these  so  as  to  ascertain  their  estimate  of  the 
separate  advantage  of  completion  so  as  to  earn  a  present  income.' 

"  If  this  means  anything,  it  means  that  the  Supreme  Court  of 
Iowa  recognized  the  propriety  of  considering  going  value  as  an 
element  of  value.  It  says  distinctly  and  affirmatively:  'The 
fact  that  the  plant  is  in  successful  operation  constitutes  an  ele- 
ment of  value.'  It  says  further:  'As  said,  the  value  of  the 
system  as  completed,  earning  a  present  income,  is  the  criterion.' 
It  calls  going  value  'an  element  of  value'  in  distinguishing  it 
from  good  will,  which  is  excluded. 

"  That  the  Iowa  Court  might  properly  have  excluded  this 
evidence  is  obvious.  It  held  that  the  testimony  failed  to  dis- 
criminate between  good  will,  which  could  not  be  considered,  and 
going  value,  which  must  be  considered;  and  the  fact  that  the 
Court  had  '  no  means  of  separating  these  so  as  to  ascertain  their 
estimate  of  the  separate  advantage  of  completion  so  as  to  earn  a 
present  income'  would  justify  excluding  the  evidence.  Ob- 
viously, if  the  Court  had  intended  to  hold  evidence  as  to  going 
value  as  well  as  good  will  incompetent,  there  would  have  been  no 
occasion  for  its  distinguishing  one  from  the  other. 

"It  is  upon  this  record  that  the  United  States  Supreme  Court 
uses  the  language  which  has  been  quoted  above,  saying  not 
that  the  Supreme  Court  of  Iowa  excluded  going  value,  but  that 
'although  it  is  argued  that  the  Court  excluded  it,  the  Court 
expressly  took  into  account  the  fact  that  the  plant  was  in 
successful  operation.' 

"If  the  Court  excluded  this  evidence,  the  complainant  could 
have  assigned  error;  and  upon  this  assignment  it  could  have 
presented  to  the  Supreme  Court  the  question  whether  or  not  the 
ruling  was  correct.  This  is  the  only  question  that  could  have 
been  made  upon  this  record.  The  opinion  of  the-  United  States 
Supreme  Court  does  not  show  whether  this  was  done,  except 
inferentially  in  the  statement  that  it  is  argued  that  the  court 
excluded  going  value.  The  Supreme  Court  of  the  United  States 
said : 


GOING  VALUE  183 

'We  perhaps  should  have  adopted  a  rule  as  to  depreciation  somowhat 
more  favorable  to  the  plaintiff,  or,  it  may  be,  might  have  allowed  this 
or  that  item  that  the  state  Court  struck  out,  but  there  is  nothing  of 
which  we  can  take  notice  in  the  case  that  could  warrant  us  in  changing 
the  result  or  in  saying  that  the  plaintiff  did  not  get  as  mueii  as  it  couhl 
expect  when  leave  was  reserved  for  it  to  try  again.' 

"The  case  was  affirmed.  Technically  and  exactly  this  ufhrin- 
ance  is  a  decision  that  the  ruling  of  the  court  below  up(ni  this 
question  of  testimony  was  correct,  assuming  that  that  (luestioii 
was  properly  made  and  argued,  and  assuming  further  that  it  is 
not  one  of  the  matters  to  which  the  court  referred  in  the  last 
extract  which  has  been  made  from  the  opinion  where  it  says  that 
in  various  respects  it  might  not  have  done  what  the  State  Court, 
did.  If  this  case  indicates  anything  upon  the  question  of  going 
value,  the  sentence,  "then  again,  although  it  is  argued  that  the 
Court  excluded  going  value,  the  Court  expressly  took  into  account 
the  fact  that  the  plant  was  in  successful  operation,"  taken  in 
connection  with  its  opinion  in  which  the  Supreme  Court  of  Iowa 
says:  "Aside  from  the  intangible  element  of  good  will,  the  fact 
that  the  plant  is  in  successful  operation  constitutes  an  element  of 
value,"  and  says  further,  "as  said,  the  value  of  the  system,  as 
completed,  earning  a  present  income  is  the  criterion,"  it  is  a  recog- 
nition of  the  fact  that  going  value  cannot  be  eliminated. 

"  Any  doubt  as  to  the  proper  construction  of  the  Cedar  Ilapiils 
case  is  settled  by  an  analysis  of  the  figures.  If  we  take  the 
valuation  of  the  physical  properties  which  the  State  Court  took 
in  the  discussion  of  the  question  and  make  the  deductions  which 
it  clearly  makes,  the  conclusion  that  the  court  included  an  allow- 
ance for  going  value  and  an  allowance  for  paving  over  mains  is 
inevitable.  The  following  computation,  with  references  to  the 
pages  of  the  opinion,  is^reported  in  144  Iowa,  where  the  various 
items  may  be  found : 


184  VALUE  FOR  RATE-MAKING 

'  Plaintiff's  chief  expert  estimated  the  phys- 
ical properties  to  be  worth'  (page  438, 
last  line) $365,564 .  41 

'This  included  $43,580  'increase  of  value  of 
pipes  and  mains  because  of  being  under- 
neath the  pavement'  (line  25,  page  437). 

'  Deduct  tlie  following  items  included  in  the 
foregoing  total  of  $365,564.41  and  definitely 
disallowed  by  the  State  Court: 

(1)  Working  capital  included  at  $25,000 
and  allowed  at  $2,500  (page  433,  line 

23) $22,500.00 

(2)  The  so-called  annex,  real  estate  in- 
tended for  future  use,  unnecessary  for 

present  use  (page  435,  line  22) 16,500.00 

(3)  Deductions  made  by  the  Court  from 
the  valuation  placed  by  the  complain- 
ant upon  its  real  estate  $15,000  to 

$20,000  (page  436,  line  20)  say 17,500.00 

(4)  Purifiers  (page  436,  line  27) 1,600.00 

(5)  Deductions  on  account  of  excessive 
price  of  cast-iron  mains  (page  436,  last 
paragraph)  say 5,000 .  00 

(6)  Marion  high  pressure  line  ^^  of  $5,483 

(page  437,  line  23) 4,112.00 

(7)  Promotion    and    organization    (page 

438,  lines  21  and  31-2) 14,943.69  82,155.69 


$283,408.72 


"  This  amount,  $283,408.72,  is  the  maximum  valuation  of  the 
physical  property  because  only  those  deductions  have  been  made 
that  are  specifically  warranted  by  the  opinion. 

"  In  the  foregoing  no  deductions  are  made  for  either  of  the 
following  items  included  in  the  S365,564.41  although  the  refer- 
ences to  these  items  in  the  opinion  unmistakably  indicate  that 
they  were  not  allowed  to  their  full  amount. 

'  Brought  forward $283,408 .  72 

(8)  Interest  during     construction     (page 

438,  lines  20  and  24) $22,415  .  00 

(9)  Engineering  (page  438,  lines  21  and 

28) 18,679.61 

(10)  Increased  value  of  mains  because  of 
being  underneath  paving  (page  437, 
line25) 43,580.00  84,674.61 

$198,734.11 


GOING  VALUE  185 

"The  Court  found  (page  439,  line  33),  'that  a  fair  vahiation  of 
the  entire  plant  is  somewhere  between  S300,U(J0  and  S3.')(),()(M).' 
A  deduction  from  this  value  of  some  amount  between  S2S3, 108.72 
and  $198,734.11  above,  will  leave  what  the  Court  allowed  for 
going  value.     The  following  conclusions  are  inevitable: 

"If  interest  during  construction,  engineering  and  increased 
value  of  mains  because  underneath  paving  were  allowed  in  full, 
then  the  value  of  the  physical  property,  aside  from  going  value, 
is  $283,408.72,  and  there  is  allowed  as  going  value  some  amount 
between  $16,591.28  and  $66,591.28. 

"To  contend  that  the  entire  item  of  paving  over  mains  was 
disallowed  in  this  case,  involves  increasing  the  allowance  for 
going  value  by  the  amount  of  this  item,  $43,580,  which  would 
make  it  somewhere  between  $60,171.28  and  $110,171.28,  an 
amount  relatively  so  large  as  to  render  this  hypothesis  extremely 
improbable. 

"  If  the  items,  interest  during  construction,  engineering  and 
increased  value  of  mains  because  underneath  paving,  be  sub- 
stantially reduced,  which  in  view  of  what  is  said  about  them  in  the 
opinion  is  clearly  what  was  done,  then  the  amount  of  such  reduc- 
tion must  be  added  to  what  otherwise  was  allowed  for  going  value. 

"This  mathematical  demonstration  removes  all  doubt  as  to  the 
construction  of  the  language  in  this  opinion  that  has  been  already 
referred  to.     The  Court  said  (page  434) : 

'The  fact'  that  the  plant  is  in  successful  opcratioir  constitutes  an 
elernent  of  value.' 

"And  again,  when  it  stated  its  conclusion  at  page  439,  the 
Cqiirtused  the  sigriifi cant  language:  .    . 

'A  careful  review  of  the  entire  record,' which  has  been  repeated,  iias 
led  to  the  conclusion 'that  a  fair  valuation  of  the  entire  plant  is  some- 
where between  $300,000  and  $350,000.' 

"Tlie  language  of  tliese-extraets  taken  in  connection  with  the 
items  which  go  to  'make  up  this  valuation  makes  it  impossible 
that  the  Court-should  have  intended  to  exclude  either  going  value 
or  appreciation  iir  the  value  bfthe  mains  oh  account  of  paving 
over  therti."  ^ 

Going  Value  in  Rate  Cases.— Going  value  is  now  usually 
recognized  as  a  part  of  utility  property  whether  the  value  is  being 
considered  in  rate  cases  or  for  purposes  of  sale.     Practically  all  of 

1  Brief  of  E.  F.  Jones  and  B.  W.  Couch,,  counsel  for  The  Peoples  Gaa  Light  Co.. 
Manchester,  N.  H.     Pages  53-58. 


186  VALUE  FOR  RATE-MAKING 

the  earlier  cases  carried  to  the  higher  courts  for  decision  were 
"sale"  cases.  That  is  the  utilities,  mostly  water-works  compan- 
ies, were  being  sold  under  contracts  of  purchase  or  condemnation 
by  cities.  Many  early  decisions  by  courts  in  the  New  England 
States  recognized  and  allowed  going  values  in  the  case  of  purchase 
of  water-works  or  gas  companies.  Later  the  Supreme  Court  in 
passing  upon  the  value  of  the  property  of  the  Omaha  Water 
Company,  which  was  being  purchased  by  the  City  of  Omaha,  in 
allowing  a  very  substantial  sum,  $562,712,  for  going  value  said, 
in  referring  to  the  Knoxville  Water  and  Consolidated  Gas  cases, 
"Both  cases  were  rate  cases  and  did  not  concern  the  ascertain- 
ment of  value  under  contracts  of  sale."  This  has  been  taken  by 
many  authorities  to  indicate  that  the  Supreme  Court  would  not 
recognize  and  allow  going  value  in  rate  cases  as  distinct  from  sale 
cases.  This  somewhat  gratuitous  assumption  has  never  been 
approved  as  a  principle  by  any  decision  of  the  Supreme  Court, 
although  in  the  Knoxville  rate  case  a  definite  amount  for  going 
value  was  included  without  the  question  being  determined 
whether  properly  so  included.  On  the  other  hand,  the  lower 
courts  and  other  authorities  have  repeatedly  allowed  going  value 
as  an  element  in  rate-making  and  have  definitely  and  expressly 
stated  that  it  makes  no  difference  whether  value  is  being  deter- 
mined for  the  purpose  of  fixing  rates  or  condemnation  and  sale, 
going  value  must  be  considered  and  allowed  as  a  part  of  the  fair 
value  of  the  property.  Some  instances  where  the  courts  have 
definitely  stated  that  going  value  is  to  be  allowed  in  rate  cases  as 
well  as  in  sale  cases  are  as  follows: 

In  the  Spring  Valley  Water-works  Company  rate  case,  where  an 
application  was  made  for  an  injunction  to  enjoin  the  enforcement 
of  a  rate,  the  injunction  was  granted,  the  opinion  stating: 

"It  is  true  this  was  a  condemnation  proceeding,  and  the  question  was 
to  determine  what  was  just  compensation  for  the  appropriation  of  cor- 
porate property  to  a  pubUc  use,  while  the  case  before  this  Court  relates 
to  the  fixing  of  water  rates  which  shall  be  a  just  compensation  for  the 
appropriation  of  complainant's  property  to  a  public  use.  It  is  not  per- 
ceived that  there  is  any  difference  in  the  principles  applicable  to  the  two 
cases,  and  this  appears  to  have  been  the  view  of  the  Supreme  Court  in 
San  Diego  Water  Co.  vs.  San  Diego,  supra"  (118  Gal.  556). 

The  complainant  in  this  case  contended,  as  stated  by  the 
Court,  that  it  had  an  established  business  as  a  water  company 


GOING  VALUE  187 

and  as  a  going  concern,  that  its  plant  had  a  vahic,  by  rcjison 
of  these  advantages,  beyond  the  mere  cost  of  roprofhiction. 
The  Court  cites  in  this  connection  the  leading  case  of  X:ilioiial 
Water- works  Co.  vs.  Kansas  City,  62  Fed.  853,  and,  after  quot- 
ing from  the  same,  adtls  the  following: 

"This  was  also  a  condemnation  proceeding,  but,  as  before  stated,  the 
principles  of  compensation  applicable  to  such  a  case  appear  to  be 
applicable  to  the  present  case."^ 

In  the  Des  Moines  Water  Company  rate  case  where  the  com- 
pany sought  to  enjoin  the  enforcement  of  an  ordinance  of  the 
City  of  Des  Moines,  fixing  rates,  on  the  ground  that  such  rates  as 
fixed  were  confiscatory,  the  master  in  chancery,  Mr.  G.  F.  Henry, 
submitted  an  unusually  carefully  prepared  report,  which  contains 
a  most  exhaustive  review  of  the  cases  on  going  value.  The  master 
comments  on  an  earlier  decision  of  the  Iowa  Court  in  the  Cedar 
Rapids  Water  Company  case,  where  the  question  of  whether  or 
not  going  value  should  be  recognized  for  rate-making  purposes. 
The  master  in  explanation  of  an  allowance  for  going  value,  which 
"when  reduced  to  dollars  and  cents  is  not  more  than  $168,277  and 
is  not  less  than  $167,251,"  that  is  practically  10  per  cent,  of  all  the 
other  elements  of  value  entering  into  the  property,  says: 

"So  far  as  I  have  been  able  to  learn  this  expression  by  the  Supreme 
Court  of  Iowa  of  seeming  doubt  as  to  the  right  to  include  in  this  "going 
value'  in  arriving  at  the  value  of  a  water-works  plant  in  determining  a 
fair  rate  of  profit  from  the  operation  of  such  a  plant,  is  the  only  expres- 
sion of  this  character  from  any  court  of  last  resort.  Several  of  the  courts, 
as  will  have  already  been  noticed,  say  that  they  know  of  no  logical  dis- 
tinction between  sale  cases  and  rate  cases  with  respect  to  the  right  to 
include  this  element  of  value.  I  see  no  logical  distinction  and  am  of  the 
opinion,  in  the  light  of  the  foregoing  authorities,  that  it  must  be 
included." 

This  decision  of  the  master  was  confirmed  in  all  respects  i)y 
Judge  McPherson  in  September,  1911,  with  the  following  state- 
ment on  the  question  of  going  value: 

"The  master  has  found  and  fixed  a  valuation  upon  this  property,  as  a 
going  concern,  as  distinguished  from  the  naked  plant.  As  to  this,  both 
reason  and  authorities  sustain  him.  Everything  of  a  business  character 
is  thus  valued.  *  *  *  A  telephone  system  may  have  its  wires,  but 
before  the  business  can  be  profitable  it  must  have  patrons.     It  takes 

1  Spring  Valley  Water-works  Company  vs.  City,  etc.,  of  San  Francisco,  124  Fed.  594.  865. 


188  VALUE  FOR  RATE-MAKING 

effort  and  money  to  get  patrons.  While  obtaining  patrons  the  capital 
stock  is  earning  but  little  or  nothing.  The  street  car  system  may  have 
laid  its  rails  and  built  its  power  plant,  and  have  bought  its  cars;  but  it 
does  not  have  the  value  that  it  afterward  will  have  when  its  business 
has  been  adjusted  and  the  people  have  adjusted  their  business  and  their 
conveniences  to  work  in  harmony  with  the  system  thus  established. 
The  newspaper  plant  may  have  its  editors  and  reporters,  and  its  presses, 
buildings,  and  offices.  The  physical  valuation  in  the  one  case  is  just 
the  same  as  in  the  other.  But  two  newspapers,  possessed  of  equal 
physical  valuation,  are  not  of  the  same  value,  as  everybody  knows.  Two 
merchants  may  have  the  same  stock  of  goods,  as  to  value,  and  may  be 
equally  well  located,  and  may  own  the  same  amount  of  real  estate,  in 
value.  It  is  not  material  whether  we  call  it '  good  will '  or  the  '  value  of  a 
going  concern,'  but  there  is  an  intangible  value  there,  and  the  owner  has 
the  right  to  have  it  determined  on  such  increased  valuation. 

"These  rules  apply  with  equal  force  to  a  water-works  system.  It 
took  a  long  time  to  build  up  the  system.  First,  it  had  to  get  in  touch 
with  the  patrons,  make  contracts,  install  meters,  and  establish  the  busi- 
ness. During  that  period  the  capital  stock  was  not  earning  what  it 
should  have  earned.  Now  that  it  is  a  going  concern,  it  is  entitled  to 
have  these  values  considered,  in  arriving  at  the  true  valuation  of  the 
plant.  Such  reasoning  is  indorsed  by  courts,  both  national  and  State 
Supreme  Courts,  and  such  conclusions  are  the  result  of  sound  reasoning. 
Such  are  the  tests  in  all  other  vocations  and  business  enterprises."^ 

The  Supreme  Court  of  the  State  of  New  York,  speaking 
through  Justice  Clark,  says  regarding  the  improper  distinction 
made  by  the  Public  Service  Commission  of  New  York,  First  Dis- 
trict, in  refusing  to  allow  anything  for  going  value  in  the  fair 
value  of  the  property  of  the  Kings  County  Lighting  Company,  a 
rate  case: 

"But  'going  value'  has  been  considered  and  allowed  for  in  the  follow- 
ing rate  cases:  Missouri,  Kansas  &  Texas  R.  R.  Co.  vs.  Love  (C.  C), 
177  Fed.  493,  496;  Shepard  vs.  Northern  Pacific  R.  R.  Co.  (C.  C), 
184  Fed.  765,  810;  Des  Moines  Water  Co.  vs.  Des  Moines  (C.  C),  192 
Fed.  193,  197;  Pioneer  Tel.  &  Tel.  Co.  vs.  Westenhaver,  29  Okl.  429, 
118  Pac.  354,  38  L.  R.  A.  (N.  S.)  1209. 

"I  am  unable  to  perceive  a  logical  difference  between  allowing  'going 
value '  in  the  valuation  of  a  plant  when  it  is  to  be  taken  entirely  by  the 
public  and  allowing  the  same  element  when  valuing  the  same  plant  for 
rate-making  purposes.  In  each  case  the  thing  to  be  done  is  the  fair 
appraisement  of  present  value.  What  difference  in  principle  can  there 
be  because  in  one  instance  all  is  taken  for  the  use  of  the  public  and  in  the 

1  192  Fed.  197. 


GOING  VALUE  189 

other  the  public  limits  the  earnings?  In  the  case  at  bar  the  Commission 
says  it  'disallowed  this  claim  in  determining  fair  value.  *  *  *  ]Jut 
did  consider  it  in  fixing  the  rate  of  return.'  If  so,  there  is  no  proof  of 
that  fact  in  the  record."^ 

The  counsel  of  the  New  York  Commission  in  arguing  on  appeal, 
before  the  Court  of  Appeals,  in  the  Kings  County  Lighting 
Company  case  above  referred  to,  criticises  the  opinion  of  ti»o 
Supreme  Court  of  the  State,  and  says: 

"A  serious  misconception  appears  in  the  following  ciuotation  from 
the  opinion  of  the  Court  below  (Vol.  A,  fol.  42) : 

'I  am  unable  to  perceive  a  logical  difference  between  allowing  "going 
value"  in  the  valuation  of  a  plant  when  it  is  to  be  taken  entirely  by  the 
public  and  allowing  the  same  element  when  valuing  the  same  i)lant  for 
rate-making  purposes.  In  each  case  the  thing  to  be  done  is  the  fair 
appraisement  of  present  value.  What  difference  in  principle  can  there 
be  because  in  one  instance  all  is  taken  for  the  use  of  the  public  and  in 
the  other  the  public  limits  the  earnings?' 

"It  is  fair  to  say  that  there  has  been  some  confusion  in  the  authorities 
because  a  principle  which  distinguishes  purchase  cases  from  rate  cases 
has  not  always  been  clearly  apprehended.'"^ 

Continuing,  the  eminent  counsel  says  that  this  distinction 
between  allowing  going  value  in  purchase  and  rate  cases  is 
illustrated  and  enforced  by  the  decision  of  the  Public  Service 
Commission  of  New  York,  Second  District,  in  the  Cataract  Power 
&  Conduit  Company  case,  which  states: 

"I  think  it  must  be  taken  as  clear  upon  principle  that  there  is  a  funda- 
mental distinction  as  to  going  concern  value  between  rate  cases  and 
cases  of  purchase." 

The  Higher  Court  of  Appeals  speaking  through  Judge  Miller, 
quotes  the  above  opinion  of  Justice  Clark,  of  the  Supreme  Court, 
adding: 

"we   concur  fully  in   what  he   has  said   on  the  subject  and  in  his 
conclusion." 

These  clear-cut  expressions  of  opinion  upon  this  particular 
point,  have  great  weight,  as,  perhaps,  never  before  has  it  been 
so  definitely  and  clearly  put  up  to  any  court  to  pass  upon  the 
question  of  whether  going  value  should  be  disallowed  in  rate  cases 

1  People  ex  rel.  Kings  County  Lighting  Co.  vs.  Wilcox  et  ah,  141  N.  Y.  Supp.  677. 

2  Brief  of  George  S.  Coleman,  Counsel  of  the  Public  Service  Commission,  First  DiBtrict. 
before  Court  of  Appeals,  State  of  New  York,  page  25. 


190  VALUE  FOR  RATE-MAKING 

in  contradistinction  to  its  allowance  in  sale  cases.  The  subject 
was  presented  to  the  court  as  one  of  four  questions,  certified  for 
review  in  the  following  explicit  form: 

"Was  the  relator  entitled,  upon  the  facts  shown  in  the  record,  to 
have  the  Commission  make  an  allowance  for  going  value  in  determining 
the  value  of  the  relator's  property  used  in  the  public  service?" 

The  decision  of  the  courts  in  the  matter  of  allowing  going  value 
in  both  rate  and  sale  cases,  would  seem  to  be  in  line  with  common 
sense,  as  no  ordinarily  intelligent  investor  would  consent  to  pay 
for  going  value  as  part  of  the  purchase  price  of  property,  and  then, 
precluded  by  the  decision  of  a  Commission  in  a  rate  case,  be 
satisfied  to  go  without  any  return  upon  that  part  of  his  invest- 
ment in  the  property  which  represented  going  value. 

The  Oklahoma  Supreme  Court  in  the  Pioneer  Telephone  rate 
case  carefully  considered  the  question  whether  going  value  should 
be  allowed  in  a  rate  case,  and  very  ably  sums  up  the  whole 
situation  in  the  following  extract  from  that  decision : 

"There  is  no  contention  that  any  value  on  account  of  unexpired 
franchise  or  for  good  will  should  be  added  to  the  reproductive  value,  in 
order  to  ascertain  the  present  value;  but  it  is  contended  that,  by  reason 
of  the  fact  that  appellant's  plant  has  an  established  system  of  operation, 
has  at  present  customers  sufficient  in  number  to  pay  the  operating  ex- 
penses and  annual  depreciation  and  some  profit,  it  has  a  value  beyond  the 
mere  cost  of  reproducing  the  plant.  This  element  of  value  contended 
for  has  been  generally  referred  to  by  the  authorities  as  'the  going-concern 
value'  or  'going  value.'  No  case  from  the  Supreme  Court  of  the  United 
States  involving  the  reasonableness  of  rates  or  charges,  wherein  this 
question  has  been  considered  by  that  court,  has  been  called  to  our 
attention.  In  Knoxville  vs.  Knoxville  Water  Co.,  supra,  the  lower  court 
added  to  the  appraisement  of  the  physical  properties  the  sum  of  $60,000 
for  going  concern  value.  The  Supreme  Court  assumed,  without  decid- 
ing, that  this  item  was  properly  added.  There  are  many  cases  wherein 
the  fair  market  value  of  public  service  property  was  involved,  under 
franchises  reserving  to  the  municipality  the  right  to  purchase  the  plant 
at  or  after  a  stipulated  time  for  the  fair  market  value  thereof.  These 
cases,  so  far  as  we  have  been  able  to  examine  them,  uniformly  hold  that, 
in  the  absence  of  a  provision  in  the  franchise  to  the  contrary,  the  going 
concern  element  of  value  must  be  considered  in  ascertaining  the  fair 
value  of  the  plant.  *  *  *  For  the  purpose  of  taxation,  it  is  well  estab- 
lished that  this  element  of  value  must  be  included  in  assessing  the 
property.      *  *  *     Whether,  however,  all  matters  which  are  considered 


GOING  VALUE  191 

in  the  foregoing  two  classes  of  cases  as  part  of  tlu-  going  valui",  for  the 
purpose  involved  in  those  cases,  should  be  considered  in  doterniiriing  llin 
value  as  a  basis  for  rate-making  is  not  necessary  U)  dctcrininc  in  this 
case.  It  is  apparent  *  *  *  that  a  complete  telephone  plant  withdut  a 
single  subscriber,  or  with  but  few  subscribers,  is  less  valuable,  both  to 
the  owner  of  the  plant  and  to  the  members  of  the  public  it  servos,  than 
the  same  plant  with  a  larger  patronage.  The  more  people  a  sub- 
scriber can  communicate  with  over  the  telephone  exchange,  the  more 
service,  as  a  general  rule,  is  such  exchange  to  him ;  and  it  is  only  when  such 
exchange  has  subscribers  that  the  property  of  the  owner  invested  therein 
has  an  earning  power.  But  subscribers  arc  not  obtained  wit  hout  expcrnli- 
ture  of  money,  labor,  and  time,  during  which  the  capital  invested  in  the 
plant  earns  nothing,  and  often  fails  to  pay  operating  expenses.  The 
customers  must  be  connected  with  the  system  of  the  plant ;  trained  em- 
ployees must  be  obtained;  and  a  system  of  operation  must  be  established. 
Few  industries,  if  any,  involving  an  investment  of  .S90,000  or  more  ran 
be  made  self-sustaining  from  the  first  day  of  their  operation.  The 
uncontradicted  evidence  in  this  case  discloses  that  appellant's  plant,  for 
the  years  preceding  the  first  hearing,  failed  to  produce  revenue  sufficient 
for  operating  expenses,  current  repair,  and  lay  aside  an  amount  for  de- 
preciation. During  the  time  of  development,  there  is  a  loss  of  money 
actually  expended  and  of  dividends  upon  the  property  invested.  How 
shall  this  be  taken  care  of?  Must  it  be  borne  by  the  owner  of  the  plant 
or  by  the  initial  customers?  Or  shall  it  be  treated  as  part  of  the  invest- 
ment or  value  of  the  plant,  constituting  the  basis  upon  which  charges 
shall  be  made  to  all  customers  who  receive  the  benefits  from  the  increased 
service-rendering  power  of  the  plant  by  reason  of  these  expenditures? 
It  seems  that  the  last  solution  is  the  logical,  just,  and  correct  one. 
If  rates  were  to  be  charged  from  the  beginning  so  as  to  cover  these  ex- 
penditures and  earn  a  dividend  from  the  time  a  plant  is  first  operated, 
the  rate  to  the  first  customers  would  be  in  many  instances,  if  not  in  all,  so 
exorbitant  as  to  be  prohibitive,  and  would  be  so  at  the  time  when  the 
plant  could  be  of  least  service  to  them.  On  the  other  hand,  the  public 
cannot  expect  as  a  business  proposition,  or  demand  as  a  legal  right,  that 
this  loss  shall  be  borne  by  him  who  furnishes  the  service,  for  investors  in 
public  service  property  make  such  investments  for  the  return  they  will 
yield;  and  if  the  law  required  that  a  portion  of  the  investments  shall 
never  yield  any  return,  but  shall  be  a  total  loss  to  the  investor,  capital 
would  unwillingly  be  placed  into  such  class  of  investments;  but  the  law, 
in  our  opinion,  does  not  so  require.  Private  property  can  no  more  be 
taken  in  this  method  for  public  use  without  compensation  than  by  any 
other  method.  When  the  use  of  the  property  and  the  expenditures  made 
during  the  non-expense-paying  and  non-dividend-paying  period  of  the 
plant  are  treated  as  an  element  of  the  value  of  the  property  upon  which 


192  VALUE  FOR  RATE-MAKING 

fair  returns  shall  be  allowed,  then  the  burden  is  distributed  among  those 
who  receive  the  benefits  of  the  expenditures  and  the  use  of  the  property 
in  its  enhanced  value.  *  *  *  AH  the  evidence  of  appellant  is  that  the 
going  concern  value  of  the  plant  in  this  case  is  equivalent  to  20  per  cent, 
of  the  reproductive  value.  This  evidence  is  not  contradicted  by  the 
state,  the  position  of  counsel  for  the  State  and  of  the  Commission  being 
that,  whatever  its  amount  is,  it  is  not  an  element  of  present  value  forming 
a  basis  for  the  earning  of  rates.  Twenty  per  cent,  of  the  reproductive 
value  is  $18,926.73,  which,  added  to  the  reproductive  value  of  the  phys- 
ical properties  found  by  the  Commission,  makes  a  total  present  value, 
on  which  appellant  is  entitled  to  receive  a  fair  return,  in  the  sum  of 
1113,560.42."! 

Without  here  referring  to  the  many  cases  of  valuation  for 
purposes  of  sale  in  which  going  value  has  been  recognized  and 
allowed  as  a  substantial  portion  of  the  total  value  of  the  property 
under  consideration,  the  following  decisions  by  the  courts  recog- 
nizing going  value  in  rate  cases  may  pertinently  be  quoted. 

As  early  as  1893,  Judge  Brewer  of  the  Supreme  Court  rendered 
a  decision  which  may  be  said  to  foreshadow  the  general  rule  with 
regard  to  going  value.  The  case  involved  the  assessment  of  a 
railroad  property  in  Indiana  for  tax  purposes,  and  antedates  the 
rather  famous  condemnation  case  of  the  National  Water-works 
Company  vs.  Kansas  City  by  one  year. 

"The  true  value  of  a  line  of  railroad  is  something  more  than  an 
aggregation  of  the  values  of  separate  parts  of  it,  operated  separately.  It 
is  the  aggregate  of  these  values  plus  that  arising  from  a  connected  opera- 
tion of  the  whole,  and  each  part  of  the  road  contributes  not  merely  the 
value  arising  from  its  independent  operation,  but  its  mileage  proportion 
of  that  flowing  from  a  continuous  and  connected  operation  of  the  whole. 
*  *  *  A  notable  illustration  of  this  was  in  the  New  York  Central  Rail- 
road consolidation.  *  *  *  Immediately  upon  the  consolidation  of 
these  companies,  and  the  operation  of  the  property  as  a  single,  connected 
line  of  railroad  between  Albany  and  Buffalo,  the  value  of  the  property 
was  recognized  in  the  market  as  largely  in  excess  of  the  aggregate  of  the 
values  of  the  separate  properties.  It  is  unnecessary  to  enter  into  an 
inquiry  as  to  the  causes  of  this.     It  is  enough  to  notice  the  fact."^ 

The  U.  S,  Supreme  Court  in  affirming  a  decision  of  the  Supreme 
Court  in  Ohio,  in  a  tax  case,  held  that  the  organism  created  by 
tangible  property  was  a  thing  of  value  far  in  excess  of  the  value 
of  the  tangible  units. 

'  Pioneer  Telephone  &  Telegraph  Company  vs.  WcBtenhaver,  118  Pac.  359. 
2  Cleveland  C,  C.  and  St.  L.  R.  Co.  vs.  Backus,  154  U.  S.  444. 


GOING  VALUE  193 

"In  the  complex  civilization  of  to-day  a  large  portion  of  tlic  wciiltli  df  a 
community  consists  of  intangible  property"  (page  218). 

"Whenever  separate  articles  of  tangible  property  are  joined  togetlicr, 
not  simply  as  a  unit  of  ownership,  but  in  a  unity  of  use,  tliere  is  not 
infrequently  developed  a  property,  intangible  though  it  be,  which  in 
value  exceeds  the  aggregate  of  the  value  of  the  separate  pieces  of  tangible 
property"  (page  219). 

"In  conclusion  let  us  say  that  this  is  eminently  a  ])ractical  age;  that 
courts  must  recognize  things  as  they  are  and  as  po.ssessing  a  value  wliich 
is  accorded  to  them  in  the  markets  of  the  world"  (page  225).^ 

In  the  Knoxville  rate  case,  already  referred  to,  where  the  master 
had  included  $10,000  for  "  organization,  promotion,  etc.,"  and 
$60,000  for  "going  concern,"  the  Covirt  in  reviewing  the  master's 
report  says,  with  regard  to  the  allowance  for  going  value: 

"  The  latter  sum  we  understand  to  be  an  expression  of  the  added  value 
of  the  plant  as  a  whole  over  the  sum  of  the  values  of  its  component  parts, 
which  is  attached  to  it  because  it  is  in  active  and  successful  operation 
and  earning  a  return.  We  express  no  opinion  as  to  the  propriety  of 
including  these  two  items  in  the  valuation  of  the  plant,  for  the  purpose 
for  which  it  is  valued  in  this  case,  but  leave  that  question  to  be  considered 
when  it  necessarily  arises.  We  assume,  without  deciding,  that  these 
items  were  properly  added  in  this  case.""-^ 

While  the  decision  of  the  Supreme  Court,  reviewing  the  decision 
of  the  Iowa  Court  in  the  Cedar  Rapids  Gas  rate  case,  is  not  as 
explicit  as  might  be  desired,  the  element  of  going  value  was  held 
to  be  properly  included  as  a  part  of  the  total  value  upon  which 
the  corporation  was  entitled  to  a  fair  return,  as  discussed  in  pre- 
ceding pages  and  shown  by  the  extract  from  the  Court'.s  decision, 
as  follows: 

"Then  again,  although  it  was  argued  that  the  Court  excluded  going 
value,  the  Court  expressly  took  into  account  the  fact  that  the  plant  was  m 
successful  operation.  What  it  excluded  was  the  good  will  or  advantage 
incident  to  the  possession  of  a  monopoly,  so  far  as  we  might  be  supposed 
to  give  the  plaintiff  the  power  to  charge  more  than  a  reasonable  price. "^ 

The  Federal  Court  in  granting  an  injunction  against  rates 
fixed  by  the  Railroad  Commission  of  Texas  held  that  the  valua- 
tion of  the  railroad  property  was  defective  in  making  no  allow- 
ance for  "established  business,"  and  adds: 

'  Adams  Express  Co.  vs.  Ohio,  166  U.  S.  185. 
2  City  of  Knoxville  vs.  Knoxville  Water  Co.,  212  U.  S.  9. 
'  Cedar  Rapids  Gas  Light  Co.  vs.  Cedar  Rapids,  223  U.  S.  669. 
13 


194  VALUE  FOR  RATE-MAKING 

"*  *  *  and  a  system  of  rates  and  charges  that  looks  to  a  valuation 
fixed  on  so  narrow  a  basis  as  that  shown  to  have  been  adopted  by  the 
Commission,  and  so  fixed  as  to  return  only  a  fair  profit  upon  that  valua- 
tion, and  which  permits  no  account  for  betterments  made  necessary  by 
the  growth  of  trade,  seems  to  me  to  come  clearly  within  the  provision  of 
the  fourteenth  amendment  to  the  Constitution  of  the  United  States, 
which  forbids  that  a  State  shall  deprive  any  person  of  property  without 
due  process  of  law,  or  deny  any  person  within  its  jurisdiction  the  equal 
protection  of  the  laws.     *     *     * 

"The  estimate  made  on  behalf  of  the  railroad  in  this  case  of  the  cost 
to  that  company  and  to  its  predecessor  company  of  the  railroad  prop- 
erty, and  the  business  of  that  company  as  it  exists  to-day,  may  not  be 
exactly  accurate — clearly  it  is  not  exactly  accurate,  but  it  seems  to  me 
that  it  is  not  beyond  the  fair  value  of  the  property,  as  it  is  shown  to 
have  been  built  up  and  constituted,  and  to  exist  to-day  as  a  going  business 
concern."' 

The  Federal  Court  in  a  case  brought  by  the  receiver  of  the  U.  S. 
Circuit  Court  for  the  Southern  District  of  Ohio,  to  compel  the 
City  of  Urbana  to  pay  rates  sufficiently  high  to  cover  a  reasonable 
value  of  the  services  rendered  in  furnishing  water,  in  determining 
what  the  property  was  reasonably  worth  as  a  basis  upon  which  to 
determine  rates,   said: 

"  It  is  well  established  that  fair  compensation  for  such  services  includes 
operating  expenses,  taxes,  cost  of  administration,  and  a  fair  yearly 
allowance  for  the  maintenance  of  the  plant  and  such  return  on  the  value 
of  the  capital  and  property  employed  as  is  just  and  reasonable.  Upon 
consideration  of  the  testimony  of  the  experts.  Hays,  Williams,  Mead  and 
Hill,  I  am  of  the  opinion  that  the  fair  reproduction  value  of  the  property 
is  1155,000,  to  which  should  be  added  $25,000  as  the  'going  value'  of  the 
property. "2 

In  a  suit  to  enjoin  the  enforcement  of  the  passenger  rate  of  2  cts. 
per  mile  and  certain  freight  rates  in  the  State  of  Oklahoma,  tem- 
porary injunction  was  granted,  the  Circuit  Court  Judge  holding 
on  the  subject  of  going  value  that: 

"An  established  railroad  system  may  be  worth  more  than  its  original 
cost  and  more  than  the  mere  cost  of  its  physical  reproduction.  It  has 
passed  the  initial  period  of  little  or  no  return  to  its  owners  which,  of 
greater  or  less  duration,  almost  always  follows  construction  and  is  not 
infrequently  marked  by  default  and  bankruptcy.  The  inevitable  errors 
in  its  building  which  finite  minds  and  hands  cannot  avoid  have  been 

»  Metropolitan  Trust  Co.  vs.  Houston  &  T.  C.  R.  Co.,  90  Fed.  688. 
'^C.  H,  Venner  Co.  vs.  Urbana  Water-works,  174  Fed.  352. 


GOING  VALUE  I95 

measurably  corrected,  time  and  effort  have  produced  a  comnuTcial 
adjustment  between  it  and  the  country  it  was  intended  to  serve,  rehitions 
have  been  established  with  patrons,  and  sources  of  traffic  have  Ik-oh 
opened  up  and  made  tributary.  In  other  words,  the  railroad,  unlike 
one  newly  constructed,  is  fully  equipped  and  is  doing  business  as  a  Koing 
concern.  It  has  attained  a  position  after  many  experiences  conunori  to 
railroad  enterprises  which  entail  loss  and  cost  not  paid  from  current 
earnings,  and  which  correspondingly  make  for  value."' 

In  a  case  brought  by  the  Water  Company  to  enjoin  enforce- 
ment of  an  ordinance  fixing  water  rates  in  the  City  of  Dos  Moines, 
the  Court  confirming  the  substantial  allowance  of  the  master  for 
going  value  says: 

"The  master  has  found  and  fixed  a  valuation  upon  this  property,  as  a 
going  concern,  as  distinguished  from  the  naked  plant.  As  to  this,  Ijoth 
reason  and  authorities  sustain  him.  Everything  of  a  business  character 
is  thus  valued.  *  *  *  A  telephone  system  may  have  its  wires,  but 
before  the  business  can  be  profitable  it  must  have  patrons.  "^ 

A  fuller  quotation  of  this  Court's  decision  has  been  given  in  the 
preceding  pages.  The  basis  for  allowing  going  value  as  found  by 
the  master,  and  the  reasoning  of  the  Court  commends  itself  for  its 
fairness  and  logic. 

In  the  gas  rate  case  in  the  City  of  Des  Moines  action  was 
brought  to  enjoin  the  enforcement  of  an  ordinance  on  the  ground 
that  the  rates  as  fixed  were  confiscatory.  The  master  in  fixing 
the  value  of  the  plant  found  a  substantial  amount  for  going 
value,  which  finding  was  sustained  by  the  Federal  Court,  which 
said: 

"A  'good  will '  and  a  'going  concern'  value  are  often  confused  and  used 
interchangeably,  and  I  am  inclined  to  believe  that  in  some  instances  the 
master's  report  is  subject  to  this  criticism.  But  whether  this  is  so  or  not 
is  not  of  much  importance,  as  it  is  more  of  a  verbal  criticism  than  a 
practical  one.  Under  the  authorities  cited,  as  well  as  others  easily 
found  from  those  cited,  a  'good  will'  ^alue,  by  reason  of  being  a  monop- 
oly such  as  a  gas  company  has  under  an  ordinance,  is  not  to  be  reckoned. 
The  item  of  $300,000  for '  going  value '  is  quite  important  in  this  case.  It 
is  contended  that  if  this  $300,000  must  be  added  and  the  consumption  of 
gas  remains  the  same,  and  the  percentage  of  dividends  allowed  by  the 
master  should  stand,  there  will  then  be  a  shortage.  The  authorities 
already  cited,  and  which  in  my  opinion  are  in  accord  with  good  sense, 

»  Missouri  Jf.  &  T.  Ry.  Co.  vs.  Love,  177  Fed.  496. 

*  Des  Moines  Water  Co.  vs.  City  of  Des  Moines,  192  Fed.  197. 


196  VALUE  FOR  RATE-MAKING 

favor  the  allowance  of  a  '  going  value.'  Every  kind  of  business,  with  no 
exceptions,  has  a  value  known  as  'going  value,'  and  such  'going  value'  is 
in  no  way  connected  with  the  monopoly  or  'good  will'  value. "^ 

Upon  granting  a  preliminary  injunction  enjoining  the  Public 
Service  Commission  of  Arizona  from  putting  into  effect  rates  it 
had  fixed,  based  upon  values  it  had  found  for  the  gas  and  electric 
properties  of  the  Phoenix  Gas  &  Electric  Light  Company 
excluding  any  allowance  for  going  value,  the  Court  said : 

"As  has  been  stated,  this  is  the  valuation  of  a  going  concern  as  dis- 
tinguished from  the  bare  bones  of  the  corporation.  The  courts  recog- 
nize a  difference  between  the  value  of  a  plant  of  this  character,  without 
customers  or  business,  and  a  plant  that  has  been  fully  established  and 
connected  up  with  a  municipal  lighting  system  and  with  the  houses, 
business  places,  and  factories  of  regular  customers.  The  present  cor- 
poration was  in  August  of  last  year  a  going  concern;  it  was  connected 
up  with  the  municipal  lighting  system,  the  houses,  business  places,  fac- 
tories and  other  institutions  of  a  prosperous  community,  and  there  was 
nothing  more  to  do  except  to  deliver  the  service,  for  which  the  corpora- 
tion was  fully  and  efficiently  equipped.  We  think  this  element  of  valua- 
tion should  be  considered  in  connection  with  the  other  elements  of 
valuation  with  the  view  of  determining  the  actual  present  value  of 
the  whole  plant. "'- 

The  Contra  Costa  Water-works  rate  case  is  sometimes  cited 
as  holding  against  any  allowance  for  going  value,  whereas  an 
examination  of  the  facts  shows  that  the  Court  apparently  held 
that  the  evidence  interpreted  or  viewed  by  the  Court  was  not 
sufficient  to  warrant  alloWance  for  going  value,  but  the  Court  at 
the  same  time  stated  it  did  not  want  to  be  understood  as  holding 
in  a  water  rate  case  that  anything  should  be  allowed  for  going 
concern-.  A  different  presentation  of  the  facts  and  upon  the 
submission  of  proper  evidence  the  Court  will,  no  doubt,  fall  in 
line  with  practically  all  courts  which  have  passed  on  this  subject. 

The  decision  of  the  Federal  Court  in  the  water  rate  case  in  San 
Francisco,^  the  decision' of  the  Supreme  Court  of  Oklahoma  in  the 
case  of  rates  of  tlie  Pioneer  Telephone  Compahy,"*  and  the  de- 
cisions of.  the  Supreme  Court  and  Court  of  Appeals  of  New  York 

iXJes  Moines  Gas  Co.  vs.  City  of  Des  Moines,  199  Fed.  204. 

^  Wm.  P.  Bonbright  et  al.  vs.  W.  P.  Geary  et  al.,  210  Fed.  44,  Corporation  Commission 
of  Arizona  et  al.;  Kelly  vs.  Same. 

^  Spring  Valley  Water-works  Co.  vs.  City,  etc,  of  San  Francisco,  124- Fed.  574. 
^  Pioneer  Tel.  &  Tel.  Co.  vs.  Westenhaver,  118  Pac.  354. 


GOING  VALUE  197 

State  in  the  gas  rate  case  of  the  Kings  County  Company'  have 
been  previously  referred  to  and  quoted  from  at  length  so  that 
they  need  not  here  be  further  cited. 

The  recent  decision  of  the  United  States  Supreme  Court  in 
case  of  the  Des  Moines  Gas  Company  is  of  particular  interest. 
The  conclusions  of  the  master,  Judge  Sloan,  and  the  confirming 
decision  of  the  District  Court  allowing  going  value  in  this  rate 
case,  have  been  referred  to  on  the  second  preceding  page.  The 
Supreme  Court  sustained  the  lower  court  and  refused  to  grant 
an  injunction  against  the  rates  provided  by  the  city  ordinance. 
Judge  Day,  who  wrote  the  opinion,  after  noting  that  the  master 
had  given  very  thorough  consideration  of  the  subject,  stated  that: 

"Before  considering  the  correctness  of  the  rulings  of  the  master  and 
their  confirmation  by  the  district  court,  it  is  proper  to  notice  that  tliere 
is  considerable  difference  between  counsel  as  to  what  the  master  actu- 
ally found,  as  to  whether  he  included  the  sum  of  S300,000  which  he  was 
disposed  to  allow  for  going  value  in  the  $2,240,000  valuation  found  by 
him,  or  whether  it  was  added  to  the  estimate  of  the  value  of  the  property 
already  made  by  him.  We  think  the  master  intended  to  value  the  prop- 
erty at  $2,240,000  exclusive  of  the  1300,000  which,  as  we  have  said,  he 
was  at  first  disposed  to  allow  for  going  value,  and  also  that  he  deducted, 
in  reaching  the  $2,100,000,  the  $140,000  claimed  by  the  Gas  Com- 
pany as  a  proper  allowance  because  of  the  cost  of  removing  and  replac- 
ing pavements,  as  above  stated.  We  think,  too,  that  it  was  the  master's 
conclusion  that,  if  the  $300,000,  which  he  was  at  first  disposed  to  allow, 
as  stated,  or  the  $140,000  for  paving,  were  included,  the  valuation  of  the 
plant  would  be  such  that  a  fair  return  could  not  be  made  upon  the  value 
of  the  property,  and  therefore  the  company  would  be  entitled  to  a 
decree  in  its  favor.  It  therefore  follows  that  the  determination  of  the 
correctness  of  the  decree  below,  confirming  the  master's  report,  depends 
upon  and  requires  a  consideration  of  these  two  items." 

Then  the  Court,  after  stating  that  the  master  was  at  first 
disposed  to  allow  $300,000  as  a  separate  item  to  cover  going  value, 
quotes  his  excellent  statements  on  going  value  as  follows: 

"It  may  be  asked  upon  what  basis  this  amount  is  determined.  The 
evidence,  followed  strictly,  might  require  me  to  make  it  higher,  could 
my  mind  rest  satisfied  that  the  'going  value'  of  this  concern  is  worth 
more,  but  I  cannot  feel  satisfied  that  such  is  the  case,  and  regard  S300,000 
as  every  dollar  it  is  worth  over  and  above  its  physical  value,  and  ni  my 
judgment,  it  is  worth  that  much  more  than  a  plant  would  be  that  had  to 

'  Kings  County  Lighting  Co.  vs.  Wilcox  et  al.,  Public  Service  Commission,  156  .\pp.  Div. 
603,  210  N.  Y.  479. 


198  VALUE  FOR  RATE-MAKING 

develop  its  business.  But  that  would  be  much  more  rapid,  in  my  judg- 
ment, than  is  estimated.  I  think  a  purchaser  would  be  willing  to  add 
this  amount  for  its  developed  business,  and  that  a  seller  would  not  be 
willing  to  sell  unless  he  got  that  much  more  than  its  physical  value, 
but  I  could  not  give  the  mental  process  by  which  this  conclusion  is 
reached  any  more  than  a  jury  could  do  so,  under  like  circumstances, 
but  it  is  nevertheless  my  judgment  under  all  the  evidence  in  the  case. 

"The  element  of  'good  will'  as  applied  to  the  ordinary  merchant  or 
manufacturer  dealing  with  the  public  generally  is  not  considered  in 
estimating  the  'going  value'  of  complainant's  plant.  It  cannot  be  con- 
sidered in  a  public  utility  like  the  one  in  question  in  this  case,  because 
the  complainant  has  a  monopoly  of  the  business  in  which  it  is  engaged  in 
the  city  of  Des  Moines,  and  those  who  desire  to  use  its  product  must  buy 
of  it.  They  have  no  choice  in  the  matter.  But  there  is  a  great  differ- 
ence even  in  a  monopoly  which  has  a  business  already  developed  and  one 
that  must  develop  it.  The  plant  of  complainant  has  all  its  parts  work- 
ing in  harmony,  performing  their  several  functions  in  producing  and 
conveying  the  gas  to  its  customers.  These  several  parts  are  not  only 
in  place,  but  have  been  brought  to  a  harmonious  operation  throughout. 
Even  the  employees  of  the  concern  are  familiar  with  their  duties  and 
experienced  in  performing  them.  But  without  business,  no  matter  how 
perfect  it  may  be,  it  would  be  unprofitable.  It  is  ready,  however,  for 
business,  and  has  the  business  to  transact.  It  was  a  small  concern  at 
the  start  in  1864,  but  its  books  show  that  it  has  had  a  steady  growth  for 
many  years  in  the  past,  and  everything  indicates  that  it  will  continue 
in  the  future.  There  is  great  difference  between  such  a  plant  and  one 
whose  business  must  be  developed.  All  a  purchaser  of  such  a  plant 
would  have  to  do  would  be  to  take  charge  of  the  plant,  'touch  the 
button,'  and  he  is  making  money  from  the  start.  There  is  no  element 
of  uncertainty  connected  with  it. 

"He  can  retain  its  experienced  employees  as  a  rule,  should  he  so 
desire,  at  the  same  wages.  There  is  no  question  that  such  a  plant  has  a 
'going  value,'  because  it  is  a  money  maker  from  the  start. 

"The  only  difficulty  is  to  determine  how  much  its  'going  value'  is 
worth.  No  interest  during  its  construction  is  allowed,  nor  anything 
that  is  included  in  the  'overhead  charges,'  which  are  part  of  the  physical 
value.  But  simply  the  fact  that  it  has  a  developed  business  that  will 
make  monej'^  for  its  owner,  with  reasonable  rates  allowed  for  the  prod- 
uct which  it  manufactures  and  sells. 

"That  'good  will,'  in  the  sense  in  which  that  term  is  generally  used 
as  indicating  that  element  of  value  which  inheres  in  the  fixed  and  favor- 
able consideration  of  customers,  arising  from  an  established  and  well- 
known  and  well-conducted  business,  has  no  place  in  the  fixing  of  valua- 
tion for  the  purpose  of  rate-making  of  public  service  corporations  of  this 
character,  was  established  in  Willcox  vs.  Consolidated  Gas  Co.,  212  U.  S. 


GOING  VALUE  199 

19,  52,  53  L.  ed.  382,  399,  48  L.R.A.  (N.S.)  1134,  29  Sup.  Ct.  Rep.  192, 
ISAnn.  Cas.  1034."! 

Judge  Day,  himself,  then  discusses  "going  value,"  as  follows: 

"That  there  is  an  element  of  value  in  an  assembled  and  established 
plant,  doing  business  and  earning  money,  over  one  not  thus  advanced,  is 
self-evident.  This  element  of  value  is  a  property  right,  and  should  be 
considered  in  determining  the  value  of  the  property,  upon  which  the 
owner  has  a  right  to  make  a  fair  return  when  the  same  is  privately  owned 
although  dedicated  to  public  use." 

Thus  far,  we  can  agree  with  what  has  been  said  in  regard  to 
going  value,  but  at  this  point  in  his  opinion,  Judge  Day  soonis  to 
confuse  "going  value"  with  "overhead  charges,"  for  which  latter 
item 

"the  master  allowed  15  per  cent,  upon  the  base  value  (exclusive  of  real 
estate)  or  $296,254,  in  addition  to  his  allowance  of  $6,923  for  organiza- 
tion expense." 

The  master,  apparently,  had  clearly  in  mind  the  fact  that 
"going  value"  was  separate  and  distinct  from  "overhead 
charges"  or  "organization  expenses,"  which  he  specified  covered 
expenditures  for  promotion,  engineering,  superintendence  during 
construction,  insurance,  contingencies,  administration  expenses, 
interest  and  taxes  during  construction,  definitely  adding 

"no  overhead  charges  that  do  not  adhere  in  and  add  to  the  cost  thereof, 
should  be  allowed  as  a  part  of  its  (the  plant's)  physical  value." 

The  Court,  apparently  overlooking  this  clear  statement  of  the 
master,  confuses  the  allowance  for  these  items  with  "  going  value," 
as  indicated  by  the  following: 

"In  this  case,  what  may  be  called  the  inception  cost  of  the  enterprise 
entering  into  the  establishing  of  a  going  concern  had  long  since  been 

incurred." 

if  *  *  *  **  *  * 

"These  items  of  expense  in  development  are  often  called  overhead 
charges,  for  which,  as  we  have  already  seen,  the  master  allowed  15  per 
cent,  upon  the  base  value." 

Then  Judge  Day,  states  that,  in  line  with  the  Cedar  Rapids 
case,^  when 

"the  value  of  the  property  fixed  as  the  master  certifies  upon  the  basis 
of  the  plant  in  successful  operation  and  overhead  charges  have  been 

1  Des  Moines  Gas  Co.  vs.  City  of  Des  Moines  et  al.  35  Supreme  Ct.  Rep.  811. 
*  Cedar  Rapids  Gas  Light  case  vs.  Cedar  Rapids,  223  U.  S.  6oo. 


200  VALUE  FOR  RATE-MAKING 

allowed  for  the  items  and  in  the  sums  already  stated,  it  cannot  be 
said,  in  view  of  the  facts  in  this  case,  that  the  element  of  the  going 
value  has  not  been  given  the  consideration  it  deserves," 

thereby  indicating  that,  in  his  opinion,  the  value  of  the  property 
as  found  by  the  master  included  going  value,  the  basis  of  his 
opinion  being  the  following  figures  of  the  master: 

Working  capital $    140,000 

Real  estate 150,000 

Reorganization  expenses 6,923 

Meters  in  stock 6,603 

Present  value  of  physical  property  aside  from 
above  items L937,402 

Total  physical  value $2,240,928 

From  the  statement  of  Judge  Day,  given  at  the  top  of  page 
199,  he  evidently  recognizes  that  going  value  is  an  element  of 
value  in  the  property  of  a  public  utility,  over  and  above  the 
value  of  the  structural  plant,  and  thought  he  was  allowing  such 
going  value  when  he  was  allowing  "overhead  charges"  and 
"organization  expenses"  which,  of  course,  was  not  the  case  as 
clearly  shown  by  the  master.  The  principal  conclusion  to  be 
drawn  from  the  Des  Moines  Gas  case  therefore  is  not  whether 
going  value  was  allowed  in  the  figures  representing  the  value  of 
the  property  accepted  by  the  Supreme  Court,  but  rather,  whether 
the  Supreme  Court  recognized  going  value  as  an  element  of  prop- 
erty value  and  thought  it  was  allowing  such  value  in  sustaining 
the  figures  fixed  by  the  master.  There  can  be  no  question  but  that 
Judge  Day  thought  he  was  basing  his  opinion  and  the  decision 
of  the  Supreme  Court  upon  a  value  which  included  going  value 
and,  even  though  he  erred  in  this,  the  principle  that  going  value 
will  be  recognized  and  allowed  by  the  Supreme  Court  still  stands, 
unaffected  by  the  Des  Moines  case. 

Going  Value,  Four  Meanings. — Although  going  value  is  used 
as  indicating  a  value  of  utility  property  which  exists  in  addition 
to  that  of  the  mere  physical  or  structural  property,  the  term  is 
employed  loosely  to  indicate  quite  different  intangible  elements. 
The  various  shades  of  meaning  may  be  grouped  into  four  general 
classes. 

First: — Expenses. — A  value  based  on  the  cost  or  estimated  cost 
of  making  a  complete  physical  plant  into  an  income  producing 
property.     This  idea  of  going  value  is  based  on  actual  expendi- 


GOING  VALUE  201 

tures  which  have  been  made  in  attaching  the  business,  securing 
customers,  advertising,  free  equipment  or  services  furnished 
consumers,  perfecting  organization  and  espirit  de  corpn  among 
employees,  and  those  other  items  which  necessitate  extra  expense 
in  originating  and  creating  a  Hve  property.  These  expenses  are 
not  in  reality  a  part  of  regular  operating  expenses  but  rather 
they  are  costs  which  are  incurred  but  once  in  the  development 
of  any  given  original  business.  They  are  quite  distinct  from 
such  costs  as  fuel  and  labor,  which  may  create  a  deficiency  in 
operating  a  property  that  has  small  or  inadequate  returns  during 
the  early  years  but  which  operating  expenses  must  necessarily  be 
incurred  in  order  to  permit  the  corporation  to  build  up  that 
ultimate  business  which  warrants  the  existence  of  the  corpora- 
tion itself.  Under  present  methods  of  public  service  regulation 
accounting,  it  is  possible  to  ascertain  the  exact  cost  of  the  class 
of  items  herein  referred  to  as  constituting  the  elements  from 
which  going  value  is  ascertained,  but  heretofore,  with  less  ex- 
acting requirements  of  bookkeeping,  the  experience  of  experts 
and  operators  of  utilities  has  been  taken  in  fixing  this  intangible 
value.  Based  on  experience  and  a  knowledge  of  the  amount  of 
money  which  corporations  are  willing  to  expend  in  order  to  ob- 
tain a  given  revenue,  one-half  or  even  the  whole  amount  of  annual 
gross  revenue  has  been  taken  as  the  measure  of  going  value. 

'-In  the  writer's  experience,  going  concern  value  has  usually  been 
found  to  be  between  the  net  and  gross  income  of  the  plant  for  a  period 
of  one  year  (at  the  date  of  taking).  It  may  be  largely  effected,  how- 
ever, by  the  period  required  for  the  development  of  the  business."' 

Based  on  the  cost  of  soHcitirig,  connecting  up  and  getting  ready 
to  supply  a  customer,  a  certain  fixed  sum  per  service,  somewhat 
frequently  taken  at  S30  per  meter  in  gas  works,  has  been  given 
as  an  arbitrary  but  fair  basis  for  determination  of  going  value. 
Still  another  rule  of  thumb  metht)d  is  to  take  a  per  cent,  of  the 
value  of  the  physical  plant  as  representing  going  value,  these 
percentages  vary  from  about  10  per  cent,  up  to  as  high  as  50  per 
cent,  or  even- 75  per  cent,  and  are  based  on  knowledge  of  the  cost 
of  obtaining  a  revenue  for  different  properties  under  various 
conditions  of  installation  and  operation. 

An  authoritative  statement  asto  the  proper  method  of  de- 
termining going  concern  value,  in  a  particular  case  says: 

»  Mr.  Leonard  Metcalf,  in  the  Tramactions  of  .the  Amer.  Society  of  Civil  Engineers, 
paper  No.  1105,  page  31. 


202  VALUE  FOR  RATE-MAKING 

"This  being  the  cost  of  developing  the  business  and  efficiency  of  the 
companj'^  from  the  beginning  of  operation  up  to  the  present  stage. 
Figures  for  determining  it  exactly  in  this  case  are  difficult  to  obtain. 

"  In  some  other  cases  when  steam  plants  constructed  under  normal 
conditions  were  operated  and  when  the  development  was  made  without 
unusual  difficulties,  it  has  been  found  from  records  and  experience  that 
going  concern  value  equals  approximately  25  per  cent,  of  plant  value. 

"  As  in  such  cases  the  physical  plant  values  are  ordinarily  aboi^t  four 
times  the  gross  earnings,  the  amount  of  the  gross  earnings  then  coin- 
cides approximately  with  going  concern  value,  and  as  going  concern 
value  will  ordinarily  be  more  closely  related  to  gross  earnings  than  to 
plant  values^  the  going  concern  value  may  be  said  to  be  approximately 
equal  to  the  amount  of  the  annual  gross  earnings  at  the  time  of  ap- 
praisal, provided  proper  judgment  has  been  exercised  in  the  develop- 
ment and  operation  of  the  property."^ 

These  somewhat  approximate  and  somewhat  arbitrary  methods 
of  fixing  going  value  have  been  frequently  recognized  and  ac- 
cepted by  courts  and  commissions.  In  the  Passaic  Gas  case,  the 
Board  of  Public  Utility  Commissioners  of  New  Jersey  accepted 
the  testimony  of  one  of  the  experts  and  allowed  30  per  cent,  of 
the  structural  value,  including  therein  certain  items  which  are 
usually  not  included  as  a  part  of  the  going  value. 

"We  are  impressed  with  the  evident  solidity  of  Mr.  Royce's  testimony 
as  to  the  ratio  of  going  value  to  structural  value.  In  order  that  there 
may  be  no  mistake  as  to  what  he  includes  in  going  value,  his  own 
definition,  explicitly  asked  for  as  a  definition,  should  be  recorded  as  given 
on  page  1425  of  the  evidence.  It  includes  practically  all  elements 
of  value  which  the  company  may  possess  outside  of  its  actual  structural 
value  and  the  intangible  worth  or  value  of  its  quick  assets. 

"Asked  explicitly  by  Judge  Armstrong:  'You  include  in  that  what- 
ever value  would  attach  to  the  franchise  value  of  (or?)  advantage  for 
the  value  of  a  going  business,  a  live  business,  producing  a  profit;  the 
prospective  increase,  and  the  opportunity  foT  the  investment  of  addi- 
tional capital  in  enlargements,  and  all  that  would  ydn?'  Mr.  Royce 
answered,  'Yes,  sir,  and  the  value  that  coqaes,  when  a  plant  is  prop- 
erly handled,  of  getting  the  apparatus  itself  into  such  shape  that  it  may 
be  worked  at  its  point  of  greatest  efficiency.  *  *  *'  (Evidence, 
pages  1425,  1426.) 

"Recalled,  Mr.  Royce,  being  asked  if  his  compilation  of  costs  t&kes  into 
account  '  the  preliminary  costs  of  the  party  which  went  to  look  over  the 

1  Testimony  of  W.  H.  Blogd,  pp.  919,  920,  before  tte  Public  Service  Cominisai'on  of 
the  State  of  Migsouri,  in  McGregoT-Noe  Hardware  Co.  vs.  Springfield  Gas  &  Elec- 
tric Co.,  1913. 


GOING  VALUE  203 

field  and  of  organizing  the  business  or  of  getting  their  franchises,'  lie 
replies  that  he  is  speaking  of  'the  company  ready  to  do  business,'  but 
adds,  correcting  himself  or  explaining  himself,  that  it  applies  'either 
before  or  after'  the  construction  of  the  plant  (Evidence,  piigo  17SM). 

"We  must  bear  in  mind  the  definition  given  by  Mr.  Royce  himself, 
when  asked  specifically  to  define  the  term  'going  value,'  as  'prac- 
tically all  the  elements  of  value  which  the  company  may  possess  outside 
of  its  actual  structural  value  and  the  tangible  worth  or  value  of  its 
quick  assets'  (Evidence,  page  1425).  With  this  definition  of  'going 
value,'  we  must  compare  his  matured  statement  that  he  would  say 
'without  any  question  that  the  minimum  of  the  going  value  of  the 
property  would  be  the  sum  of  those  three  items,  or  perhaps  30  per  cent, 
of  the  structural  value  of  the  plant;  and  roughly  speaking  and  con- 
sidering that  we  are  to  take  up  a  new  proposition  of  tliis  kind  I  tliink 
we  should  have  to  spread  that  amount  in  the  variation  of  the  going 
value'  (Evidence,  page  1787). 

"Structural  value,  according  to  Mr.  Royce,  includes  contractor's 
profit  on  structures.  His  estimate  of  30  per  cent,  moreover  is  a  mini- 
mum (Evidence,  page  1787);  but  'for  purposes  of  this  kind  that  would 
be  a  fair  basis'  (Evidence,  page  1862).  He  testified  out  of  a  wide 
experience  that  this  is  a  fairly  common  or  average  allowance  for  going 
value.     He  testified  that  in  the  case  of  this  particular  company: 

*I  believe  that  the  actual  cost  of  developing,  of  getting  the  new 
business  and  of  creating  efficiency  in  operation,  together  with  some 
losses,  during  the  various  periods  of  construction,  has  been  at  least 
30  per  cent,  of  the  actual  structural  cost.' 

"He  was  unshaken  on  cross-examination,  and  made  clear  that  this 
percentage  applied  not  merely  to  the  structural  cost  with  which  a 
company  might  start  in  business,  but  to  the  structural  cost  of  ex- 
tensions as  well  (Evidence,  page  1849).  He  is  also  on  record  that  this 
value  of  going  concern  does  not  suffer  depreciation  (Evidence,  page 
1865),  but  is  fully  as  stable  as  real  estate  (Evidence,  page  1866).  In 
the  absence  of  accounting  records  going  back  more  than  al)Out  a  dozen 
years,  and  in  view  of  the  very  wide  expert  experience  of  untlerlying  and 
supporting  Mr.  Royce's  testimony,  we  incline  to  think  that  30  per  cent, 
of  present  structural  value,  new,  may  well  be  taken  as  a  fair  presumptive 
measure  of  the  total  going  concern  value  of  the  company.  This  30 
per  cent,  is  to  be  taken  on  the  fair  structural  value,  new,  of  the  com- 
pany's plant  and  distribution  system,  working  capital  being  excluded."' 

Similarly  the  Oklahoma  Supreme  Court  added  20  per  cent,  to 
the  "reproductive  value"  of  the  physical  properties  as  found  l)y 
the  Oklahoma  Corporation  Commission  in  overruling  that  Coin- 

>  Hearing  on  Rates  of  the  Public  Service  Gas  Company,  before  the  board  of  Public 
Utility  Commrs.,  Dec.  26,  1912,  page  42. 


204  VALUE  FOR  RATE-MAKING 

mission  and  establishing  the  correct  value  upon  which  to  fix 
rates.  ^ 

The  special  master  in  the  Des  Moines  Water  Company  case 
fixed  the  going  concern  value  at  practically  10  per  cent,  of  the 
physical  value  of  the  property,^  and  other  similar  instances  might 
be  cited. 

While  proper  weight  must  be  given  to  the  testimony  and  ex- 
perience of  men  qualified  to  speak  on  the  subject,  this  method  of 
determining  going  value  is  not  always  as  satisfactory  to  some 
minds  as  certain  other  methods  which  can  be  worked  out  with 
greater  mathematical  exactness.  Moreover,  it  will  be  recognized 
that  the  ratio  of  going  value  to  the  cost  of  physical  property  is 
not  constant  under  varying  conditions  such  as  the  comparatively 
high  price  of  labor  and  materials  in  one  property,  as  against  the 
low  cost  of  these  elements  in  another  property,  or  the  saturation 
of  the  territory  as  against  the  undeveloped  business  of  a  second 
corporation  or  the  investment  required  in  one  class  of  utility 
property  which  may  be  relatively  large  per  dollar  of  revenue,  as 
compared  with  the  investment  required  by  another  utility  of  an 
entirely  different  type. 

Second: — Deficiency. — Going  value  has  sometimes  been  defined 
by  the  use  of  the  term  "development  expenses,"  meaning  the  de- 
ficiency in  revenue  to  provide  operating  expenses  and  fair  return, 
which  deficiency  accrues  in  practically  every  utility  during  the  first 
few  years  of  operation,  while  the  business  is  being  attached  and 
the  revenue  built  up  to  a  point  that  justifies  the  existence  of  the 
utility.  Where  information  is  lacking  as  to  the  actual  deficiency 
in  the  amount  heretofore  earned,  as  compared  with  the  amount 
which  should  be  earned  in  order  to  make  a  fair  return  to  the 
utility  on  the  value  of  its  property,  existing  going  value  may  be 
estimated  by  computing  the  similar  loss  that  would  accrue  to  a 
utility  assumed  to  begin  construction  of  its  plant  at  the  present 
time,  compared  with  the  actual  revenue  of  the  existing  plant. 
The  condition  is  almost  inconceivable  that  any  public  utility 
corporation  can  earn  a  fair  return  upon  the  value  of  its  property 
from  the  very  first  day  it  is  started.  Comparatively  few  cor- 
porations have  been  able  to  earn  a  gross  income  even  for  the  first 
year,  in  which  complete  operation  begins,  that  is,  sufficient  to 
provide  operating  expenses,  taxes  and  a  fair  return  upon  the  in- 

1  Pioneer  Telephone  &  Telegraph  Co.  vs.  Westenhaver,  118  Pac.  354. 
^  Des  Moines  Water  Co.  vs.  City  of  Des  Moines,  192  Fed.  193. 


GOING  VALUE  205 

vestment.  One  of  the  single  notorious  instances  of  this  class  was 
the  subway  in  New  York  City,  which  being  financed  largely  on 
municipal  credit,  has  relatively  low  fixed  charges. 

The  fairness  and  appropriateness  of  recognizing,  as  a  part  of 
the  cost  of  a  property,  the  expense  of  constructing  the  business 
apart  from  and  in  addition  to  the  physical  property  is  not  a  new 
or  modern  idea. 

At  least  70  years  ago,  in  1845,  Asa  Whitney  made  a  definite 
estimate  of  the  probable  development  cost,  or  deficit  in  fair  re- 
turn, of  the  Northern  Pacific  Railway.^ 

The  Railroad  Commission  of  Wisconsin  early  recognized  the 
fact  that: 

"New  plants  are  seldom  paying  at  the  start.  Several  years  arc  usu- 
ally required  before  they  obtain  a  sufficient  amount  of  business  or  earn- 
ings to  cover  operating  expenses,  including  depreciation  and  a  reason- 
able rate  of  interest  upon  the  investment.  The  amount  by  which  the 
earnings  fail  to  meet  these  requirements  may  thus  be  regarded  as 
deficits  from  the  operation.  These  deficits  constitute  the  cost  of  build- 
ing up  the  business  of  the  plant.  They  are  as  much  a  part  of  the  cost 
of  building  up  the  business  as  loss  of  interest  during  the  construction 
of  the  plant  is  a  part  of  the  cost  of  its  construction.  They  are  taken 
into  account  by  those  who  enter  upon  such  undertakings,  and  if  they 
cannot  be  recovered  in  some  way,  the  plant  fails  by  that  much  to 
yield  reasonable  returns  upon  the  amount  that  has  been  expended  upon 
it  and  its  business.     *  *  * 

"The  cost  of  developing  a  business  of  water-works  may  be  made  up 
of  many  different  kinds  of  expenditures.  It  may  include  the  cost  of 
advertising,  sohciting,  demonstrations  showing  the  advantage  of 
having  water  under  pressure  in  the  houses,  of  making  free  connections, 
of  the  granting  of  lower  than  the  regular  rates,  and  of  many  other 
outlays  of  this  character  in  order  to  secure  customers.  It  may  also 
include  losses  to  the  investors  because  of  the  fact  that  the  plant  in  their 
earlier  years  failed  to  earn  enough  to  meet  all  the  requirements  for 
operating  expenses,  including  depreciation  and  a  reasonable  return 
upon  the  investment.  If  the  direct  outlays  for  securing  business  are 
charged  to  operating  expenses,  as  they  should  be,  instead  of  to  the  capital 
account,  then  the  cost  of  acquiring  a  paying  business  would  be  repre- 
sented by  the  deficits,  or  by  the  amounts  by  which  the  gross  earnings 
fall  short  of  covering  the  cost  of  operation,  as  stated,  including  fair  re- 
turns to  the  investors.     *  *  * 

"It  thus  appears  that  the  cost  of  building  up  the  business  of  a  plant 
is  in  most  cases  as  unavoidable  as  the  cost  of  the  construction  of  the 

'  "Engineering  and  Contracting,"  Aug.  19,  1914,  page  1G9. 


206  VALUE  FOR  RATE-MAKING 

plant  itself;  that  when  such  costs  are  incurred,  they  must  be  reim- 
bursed in  some  form  bj^  the  consumers  in  order  that  capital  may  be 
secured;  that  such  reimbursement  is  equitable  as  between  investors 
and  consumers;  and  that  this  is  a  just  method  of  dealing  with  such  costs 
for  other  reasons.  If  this  is  sound,  it  also  follows  that  the  cost  of  the 
business  must  also  be  taken  into  consideration  in  determining  the  value 
of  the  plants  for  rate-fixing  purposes. "^ 

The  principles  enumerated  above  have  been  adhered  to  con- 
sistently by  the  Wisconsin  Commission  in  a  large  number  of 
other  decisions  so  that  this  method  of  measuring  going  value  by 
past  deficits  has  very  generally  become  to  be  known  as  the  "Wis- 
consin Method."  More  recently,  this  same  Commission  has 
given  consideration  and  apparently  based  allowance  for  going 
value  upon  other  lines  of  proof  than  the  deficit  method,  namely, 
upon  the  comparative  plant  basis  which  is  discussed  hereafter. 
The  Wisconsin  or  "deficit  method"  of  estimating  going  value 
has  been  quite  widely  recognized  and  followed  by  other  public 
authorities  and  courts.  The  Supreme  Court  of  Wisconsin  in  a 
recent  decision  upheld  the  Wisconsin  Commission  in  its  allow- 
ance of  going  value  to  the  Appleton  Water-works  Company 
based  on  the  deficit  method,  although  the  physical  property 
was  not  in  the  best  of  condition  and  the  revenue  was  not  suffi- 
cient to  pay  all  operating  expenses,  an  allowance  for  depreciation 
and  a  fair  return  on  the  value  of  the  property. 

Because  of  the  fact  that  deficits  always  accrue  at  the  start, 
the  Oklahoma  Court  has  definitely  recognized  that  fact  and 
stated  such  losses  should  be  capitalized. 

"Few  industries,  if  any,  involving  an  investment  of  $90,000  or  more, 
can  be  made  self-sustaining  from  the  first  day  of  their  operation.  *  *  * 
During  the  time  of  development  there  is  a  loss  of  money  actually  ex- 
pended and  of  dividends  upon  the  property  invested.  How  shall  this 
be  taken  care  of?  *  *  *  or  shall  it  be  treated  as  part  of  the  investment 
or  value  of  the  plant,  constituting  the  basis  upon  which  charges  shall 
be  made  to  all  customers  who  receive  the  benefits  from  the  increased 
service-rendering  power  of  the  plant  by  reason  of  these  expenditures? 
It  seems  that  the  last  solution  is  the  logical,  just,  and  correct  one."^ 

The  Public  Service  Commission  of  New  Hampshire  has  said: 

"Technically,  depreciation  should  be  made  good  out  of  earnings. 
But  it  is  out  of  the  question  for  this  company  to  make  good  out  of  its 

•  Hill  V8.  AntiKO  Water  Co.,  3  W.  R.  C.  R.  623. 

*  Pioneer  Telephone  &  Telegraph  Co.  vs.  Westenhaver,  118  Pac.  354. 


GOING   VAIA-E  207 

earnings  a  loss  of  $250,000.  We,  tlioreforo,  find  that  justice  to  tl..' 
company,  and  the  public  good  alike,  reciuire  that  the  delicier»ry  i„  (|„. 
present  depreciated  value  of  the  company's  pn.perty,  Iwlow  th.;  amount 
actually  invested  by  the  stockholders,  be  regarded  as  a  cost  of  dovelo|H 
ing  the  business  and,  as  such,  added  to  any  depreciated  value  to  dot«T- 
mine  the  present  fair  value  of  the  company's  i)r()p('rty  devoted  t(.  the 
public  service;  and  that  the  company  should,  hereafter,  be  allowed  to 
earn  annually  a  fair  return  upon  $1,402,750,  the  amount  of  its  h<,„.i 
fide  investment.     *  *  *     " 

"The  present  depreciated  value  of  the  property,  exchidrng  .ii)- 
preciation  in  land  values,  is  $1,050,000.  There  has,  therefore.  l).<en  :i 
total  depreciation  of  $450,000  of  which  $100,000  has  been  made  good 
out  of  earnings,  while  the  balance  of  $350,000  remains  a  loss  to  the  stock- 
holders, unless  it  is  in  some  way  made  good  to  them."' 

The  Court  of  Appeals  of  New  York  State  has  recognized  and 
approved  the  deficit  method  for  measuring  going  value. 

"It  takes  time  to  put  a  new  enterprise  of  any  magnitude  on  its  feet, 
after  the  construction  work  has  been  finished.  Mistakes  of  con- 
struction have  to  be  corrected.  Substitutions  have  to  be  made. 
Economies  have  to  be  studied.  Experiments  have  to  be  made,  which 
sometimes  turn  out  to  be  useless.  An  organization  has  to  be  perfected. 
Business  has  to  be  solicited  and  advertised  for.  In  the  case  of  a  ga.s 
company,  gratuitous  work  has  to  be  done,  such  as  selling  appliances  at 
less  than  a  fair  profit  and  demonstrating  new  devices  to  induce  con- 
sumption of  gas  and  to  educate  the  public  up  to  the  maximum  point  of 
consumption.  None  of  those  things  is  reflected  in  the  value  of  the 
physical  property,  unless,  of  course,  exchange  value  be  taken,  which 
is  not  admis-sible  in  a  rate  case.  The  company  starts  out  with  the 
"bare  bones"  of  the  plant,  to  borrow  Mr.  Justice  Lurton's  phrase  in 
Omaha  Water-works  Case,  supra.  By  the  expenditures  of  time,  labor, 
and  money,  it  coordinates  those  bones  into  an  efficient  working  organ- 
ism, and  acquires  a  paying  business.  The  proper  and  reasonable 
cost  of  doing  that,  whether  included  in  operating  expenses  or  not,  is  a.s 
much  a  part  of  the  investment  of  the  company  as  the  cost  of  the  physical 
property. 

Investors  in  a  new  enterprise  have  to  be  satisfied  as  a  rule  with 
meager  or  no  returns  while  the  business  is  being  built  up.  In  a  busi- 
ness subject  only  to  the  natural  laws  of  trade,  they  expect  to  make  up 
for  the  early  lean  years  by  large  profits  later.  In  a  business,  classified 
among  public  callings,  the  rate-making  power  must  allow  for  the  losses 

'  Report  of  P.  S.  Commission,  State  of  New  Hampshire  No.  D-159.  Vol.  II.  No.  2.  Not. 
20,  1914,  page  90. 


208  VALUE  FOR  RATE-MAKING 

during  the  lean  years,  or  their  rate  will  be  confiscatory,  and  of  course 
will  drive  investors  from  the  field. 


To  view  the  matter  in  another  aspect,  take  the  case  of  a  public  service 
corporation  with  a  plant  constructed  just  ready  to  serve  the  public.  It 
is  going  to  take  time  and  cost  money  to  develop  the  highest  efficiency  of 
the  plant  and  to  establish  the  business.  Three  courses  seem  to  be  open 
with  respect  to  rate-making,  viz.:  (1)  To  charge  rates  from  the  start 
sufficient  to  make  a  fair  return  to  the  investor  and  to  pay  the  develop- 
ment expenses  from  earnings,  a  course  likely  to  result  in  prohibitive 
rates,  except  under  rare  and  favorable  circumstances;  (2)  to  treat  the 
development  expenses  as  a  loss  to  be  recouped  out  of  earnings,  but  to  be 
spread  over  a  number  of  years,  in  other  words,  as  a  debt  to  be  amortized 
— that  involves  complications,  but  would  seem  to  be  fairer  to  the  public, 
and  certainly  more  practical  than  the  first;  (3)  to  treat  the  development 
expenses,  whether  paid  from  earnings  or  not,  as  a  part  of  the  capital 
account  for  the  purpose  of  fixing  the  charge  to  the  public.  The  last 
course  would  seem  to  be  fairest  to  both  the  public  and  the  company,  as 
well  as  the  most  practical."^ 

The  New  York  Court's  decision,  as  to  going  value,  is  based 
on  a  practical  consideration  of  the  way  a  public  utility's  revenue 
is  built  up,  but  the  following  dicta  in  the  same  case  to  the  effect 
that  no  going  value  exists  in  case  of  a  successful  corporation,  is 
apparently  neither  good  law  nor  good  logic,  as  clearly  shown  by 
Judge  Day  of  the  Supreme  Court  in  the  recent  decision  of  Des 
Moines  Gas  Company  case,  where  Judge  Day  quotes  and  ap- 
proves the  following  statement  of  the  master:  "There  is  no 
question  that  such  a  plant  has  a  'going  value,'  because  it  is  a 
money  maker  from  the  start. "^ 

"  Making  proper  allowance  for  the  matters  just  considered  and  perhaps 
for  others  which  do  not  occur  to  me,  I  define  'going  value'  for  rate  pur- 
poses as  involved  in  this  case  to  be  the  amount  equal  to  the  deficiency 
of  net  earnings  below  a  fair  return  on  the  actual  investment  due  solely 
to  the  time  and  expenditures  reasonably  necessary  and  proper  to  the 
development  of  the  business  and  property  to  its  present  stage,  and  not 
comprised  in  the  valuation  of  the  physical  property. 

"It  may  be  conceded  that  going  value  has  no  existence  apart  from 
tangible  property  and  that  commercially  there  is  but  one  value,  that 
of  the  property  as  a  whole,  but  as  the  rate  cannot  be  made  to  depend 
upon  the  exchange  value,  which  would  in  turn  depend  upon  the  rate,  it 

•  People  ex  rel.  Kings  County  Lighting  Co.  vs.  Wilcox,  210  N.Y.,  479. 

^  Des  Moines  Gas  Co.  vs.  City  of  Des  Moines,  et  al.,  35  Supreme  Court  Rept.  811. 


GOING  VALUE  209 

would  seem  to  be  necessary  to  appraise  the  physical  property  and  the 
going  value  separately,  and  of  course  that  is  the  case  if  the  cost  of 
reproduction  rule  be  adopted. 

"It  remains  to  consider  how  'going  value'  is  to  be  appraised. 

"Obviously,  the  most  satisfactory  method  is  to  show  the  actual 
experience  of  the  company,  the  original  investment,  its  earnings  from 
the  start,  the  time  actually  required  and  expenses  incurred  in  Ijuilding 
up  the  business,  all  expenditures  not  reflected  by  the  present  condition 
of  the  physical  property,  the  extent  of  which  bad  managoinont  or  othf-r 
causes  prevented  or  depleted  earnings,  and  any  other  facts  bearing  on 
the  question,  keeping  in  mind  that  the  ultimate  act  to  be  determined  is 
not  the  amount  of  the  expenditures,  but  the  deficiency  in  the  fair  return 
to  the  investors  due  to  the  causes  under  consideration.  The  business 
in  this  case  was  20  years  old,  the  books  of  the  old  company  were  not 
available,  and  it  is  of  course  problematical  whether,  if  produced,  they 
would  have  shown  the  necessary  facts.  The  question,  therefore,  had 
to  be  determined,  as  all  questions  of  fact  have  to  be,  by  the  best  evidence 
available.  Here,  I  may  repeat,  that  mere  difficulty  in  the  proof  would  not 
justify  a  confiscatory  rate.  The  value  of  the  physical  property  was 
shown  by  opinion  evidence  as  to  the  cost  of  reproduction.  The  same 
kind  of  evidence  was  given  by  two  witnesses  for  the  relator  as  to  the 
cost  of  building  up  the  business  to  its  present  state. "^ 

The  conclusion  stated  that  going  value  "equals  the  deficiency 
in  net  earnings"  would  seem  to  assume  that  possibly  large,  past 
profits,  declared  as  dividends,  do  not  belong  to  the  stockholders 
of  that  period  and  because  such  dividends  were  not  put  into  the 
property  to  wipe  out  that  part  of  the  capital  investment  nece.';- 
sarily  required  to  build  up  the  business  and  revenue  of  the 
corporation,  therefore  the  existing  stockholders  may  now  be 
penalized  by  reducing  the  value  of  their  property  to  that  merely  of 
the  structural  plant.  Or  again,  if  by  unusual  opportunity,  fore- 
sight and  ability,  the  owners  of  a  property  have  been  able  to  wipe 
out  the  early  losses  incurred  in  creating  the  revenue,  then  the 
value  of  their  property  is  to  be  that  much  less  than  the  value  of  an 
identical  property  elsewhere,  operating  under  ordinary  condi- 
tions, with  normal  ability,  the  early  losses  of  which  have  not  been 
recovered. 

If,  on  the  one  hand,  the  deficit  theory  of  measuring  going  value 
is  to  be  limited  in  its  application— and  very  properly  so— to  the 
normal  period  in  which  the  normal  property  will  put  itself  upon  a 

1  People  ex  rel.  Kings  County  Lighting  Co.  vs.   Wilcox,  Court  of  Appeals,  decision  ren- 
dered  Apr.  24,  1914.      210   N.  Y.,  479. 
14 


210  VALUE  FOR  RATE-MAKING 

paying  basis,  thereby  excluding  the  property  which  is  unsuccessful 
or  which  takes  an  abnormally  long  period  in  which  to  prove  itself 
a  success,  then,  on  the  other  hand,  logically  and  fairly,  the  same 
normal  measure  of  going  value  must  be  allowed  the  exceptionally 
successful  corporation  which  puts  itself  on  a  paying  basis  in  an 
abnormally  short  period.  The  normal  cost  of  developing  the 
business  must  be  allowed  as  a  part  of  the  value  of  the  property 
of  the  successful,  or  abnormally  successful  corporation  just  the 
same  as  that  same  normal  cost  would  be  allowed  the  unsuccessful 
corporation  regardless  of  the  fact  that  the  actual  cost  may  have 
been  much  larger  than  what  is  or  what  should  be  recognized  as  the 
normal  cost  of  developing  the  business. 

Criticism  of  the  New  York  Courts'  conclusions  in  the  above 
quoted  excerpt  from  the  Kings  County  decision  has  been  made  by 
one  of  the  most  eminent  legal  authorities  in  rate  questions,  the 
late  Mr.  Chas.  F.  Mathewson,  of  New  York,  and  is  here  quoted  at 
length: 

"In  one  respect  I  venture  to  disagree  with  the  expressions  of  the 
learned  Judge  who  wrote  the  opinion  in  the  case  last  quoted. 

"He  defines  'going  value'  for  'rate  purposes'  as  'the  amount  equal  to 
the  deficiency  of  net  earnings  below  a  fair  return  on  the  actual  invest- 
ment' due  to  the  expenditures  reasonably  incurred  in  the  development 
of  business  and  property  of  the  company,  in  addition  to  the  value  of  the 
physical  property.  I  believe  it  to  be  the  sound  doctrine  that  such 
expenditure  represents  the  value  of  the  'going  concern'  development, 
whether  there  is  a  deficiency  in  net  earnings  by  reason  of  such  expendi- 
ture or  not.  The  language  of  the  learned  Justice,  literally  read,  would 
indicate  that  there  could  be  no  'going  concern'  value  in  the  case  of  a 
corporation  which  earned  a  fair  return  on  the  investment  from  the 
beginning;  and  while  the  discussion  may  be  academic  because  there  is 
rarely  found  such  a  corporation,  yet  his  proposition  as  quoted  is 
believed  to  be  unsound.  Thus,  a  street  railway  system  may  be  prof- 
itable and  pay  adequate  dividends  from  the  outset;  and  yet  it  takes 
years,  as  in  the  case  of  the  Metropolitan  System,  and  a  large  expenditure, 
to  acquire  the  experience  and  knowledge  of  conditions  and  traffic  and 
methods  of  operation  which  will  produce  the  best  results,  which  expendi- 
tures will  not  have  to  be  repeated,  which  would  not  have  been  necessary 
had  the  management  been  omniscient  at  the  outset,  and  the  result  of 
which  is  a  fund  of  knowledge  and  efficiency  for  which  a  purchaser  would 
gladly  pay  as  part  of  the  capital  value  of  the  enterprise.  This  knowledge 
and  experience  is  just  as  valuable  to  the  owner  of  the  property,  and  forms 
just  as  important  a  part  of  the  whole  investment,  whether  the  moneys 


GOING  VALUE  -JH 

which  purchase  the  experience  and  produce  and  devcldp  the  hu.sinc«s 
conies  from  rates  paid  by  consumers  or  from  capital  horrowed  hy  the 
owner. 

"If  the  company  was  permitted  in  default  of  regulation  by  the  lenis- 
lature  to  charge  rates  so  high  that  it  was  able  to  pay  excessive  dividends 
to  stockholders,  as  well  as  to  meet  the  expenditures  of  this  experimental 
period  which  produces  the  'going  concern  value,'  that  was  merely  the  go(»d 
fortune  of  the  stockholders.  What  they  earned  and  paid  to  themselves 
in  dividends  belongs  to  them  and  cannot  be  taken  away;  and  it  df)es  not 
in  any  way  conflict  with  the  proposition  that  the  development  of  their 
business  and  the  passing  through  the  experimental  period  of  its  opera- 
tion at  a  large  expense,  never  to  be  repeated,  produce  an  element  of 
value  in  the  whole  business  which  is  not  dependent  for  its  existence  uiK»n 
the  source  from  which  the  moneys  came  which  produced  it,  or  the  (\uvs- 
tion  as  to  whether  it  resulted  in  a  curtailment  of  dividends  while  it  wa.s 
being  developed.  This  we  believe  to  be  the  view  of  the  weight  of 
authority."^ 

In  this  connection  it  should  be  noted  that  in  the  Passaic  Cias 
case,  where  the  Public  Utility  Commissioners  of  New  Jersey  have 
allowed  practically  30  per  cent,  of  the  value  of  the  physical  prop- 
erty, including  working  capital,  as  an  additional  amount  repre- 
senting going  value,  the  sum  of  $4,750,000,  being  the  value 
of  the  property  upon  which  rates  were  fixed,  the  Supreme 
Court  of  New  Jersey  very  properly  upheld  the  conclusion  of  the 
Commission,  to  the  effect  that  even  if  the  costs  incurred  in  devel- 
oping the  business  had  been  paid  for  out  of  previous  earnings, 
exacted  from  the  consumers,  nevertheless  going  value  should 
properly  be  allowed  in  determining  the  present  fair  value  of  the 
property,  on  which  rates  should  be  fixed. 

With  regard  to  the  use  of  early  deficits  as  a  measurement  of 
present  going  value,  it  may  justly  be  argued  that, it  is  not  logical 
to  use  historic  values  in  connection  with  present  cost  figures 
when  the  endeavor  is  to  ascertain  present  value.  Such  criticism 
is  fair  if  strict  reproduction  cost  method  is  being  employed,  in 
which  case  it  is  better  and  more  logical  to  determine  going  value 
based  on  an  estimate  using  the  revenue  of  existing  plant,  as  has 
been  done  by  the  Wisconsin  Commission  for  example  in  the 
Milwaukee  Gas  Company  case. 

The  early  deficit  method  is  sometimes  unfairly  criticized,  be- 
cause if  followed,  without  the  limitation  of  reason  and  experience 

'"Some  Legal  Aspects  of  Regulation  of  Public  Service  Corporationa."  by  Charles  F. 
Matbewsoo,  May  11,  1914,  page  24. 


212  VALUE  FOR  RATE-MAKING 

as  to  what  are  normal  conditions,  it  leads  to  absurd  results,  in 
that  an  unprofitable  business  will  have  greater  going  value  than 
one  that  is  profitable  from  the  start.  As  the  Court  of  Appeals  of 
New  York  has  stated: 

"It  is  urged  that  an  unprofitable  business  will  thus  have  a  greater 
value  for  rate-making  purposes  than  one  profitable  from  the  start. 

"That  again  overlooks  the  fundamental  consideration  that  a  public 
service  corporation  is  entitled  to  a  fair  rate  of  return  from  the  beginning 
of  its  investment  and  no  more.  If  the  shareholders  have  been  deprived 
of  a  fair  return  on  their  investment,  because  of  the  time  and  expense 
reasonably  and  properly  required  to  build  up  the  business,  they  have, 
to  the  extent  of  that  deprivation,  added  to  their  original  investment  and 
are  entitled  to  a  return  upon  it."^ 

Third: — Incoyne. — Going  value  is  sometimes  used  to  mean  that 
value  which  is  derived  from  a  consideration  of  capitalizing  net 
earnings. 

"It  would  not  have  fulfilled  its  duty  had  it  estimated  the  sum  to 
be  paid  in  view  only  of  what  the  lands,  buildings,  pipes,  wires,  and 
other  apparatus  were  worth,  considered  as  separate  items.  They  were 
to  be  valued  in  view  of  their  arrangement  for  and  adaptability  to  the 
purposes  for  which  they  were  provided,  and  of  their  earning  capacity  as 
a  going  concern,  in  ascertaining  which  special  regard  was,  by  the 
terms  of  the  statute,  to  be  paid  for  their  actual  earnings."^ 

While  good  will  is  usually  not  considered  an  element  to  be 
recognized  in  valuing  a  public  utility  that  is  a  monopoly,  going 
value,  that  is  evaluated  from  a  consideration  merely  of  net 
earnings,  is  in  that  sense  closely  allied  to  good  will,  and  may 
perhaps  be  fairly  applied  in  determining  the  value  of  the  business 
of  a  private  corporation  but  has  no  place  in  consideration  of  value 
upon  which-  to  base  a  fair  return  when  considering  a  public  utility 
corporation  operating  as  a  controlled  monopoly. 

Value  determined  from  a  consideration  of  net  earnings  is  usually 
based  principally  iipon  the  rate  of  interest,  the"  degree  of  risk  and 
the  present  and  prospective  earnings.  Therefore,  market  value 
resulting  ultimately  from  prospective  net  returns  depends  upon 
rates  and,  hence,  cannot  alone  be  used  in  fixing  those  rates.  In 
cases  of  condemnation  for  purchase  and  sale,  where  rates  are  not 

'  Court  of  Appeals,  State  of  New  York,  in  The  People  ex  rel.  Kings  County  Lighting 
Company  V8.  Wilco'x  el  ai:.  Composing  Public  •Service  Coiiunission,  First  District,  Mar.  24, 
1914.   210.  N.  V.  479. 

^  Norwich  Gas  &  Electric  Co.  vs.  City  of  Norwich,  57  All.  751. 


aorxa  vaijje  213 

under  criticism,  have  not  boon  sliown  to  be  unfair  or  porlmps  hiivo 
been  approved  or  authorized  by  constituted  pul^lic  authorities, 
then  in  such  cases  the  capitahzation  of  net  earnings  nmy  l>c 
used  as  one  measure  of  going  value.  It  would  be  the  difTcrenco 
between  the  capitalized  amount  of  the  net  earnings  and  the  ap- 
praised value  of  the  physical  property,  assuming  the  total  valu(! 
is  covered  by  these  two  elements.  As  a  matter  of  fact,  the  {as- 
certainment of  the  two  elements,  going  value  and  jjliysical 
property,  would  be  unimportant  in  case  capitalized  value  alone; 
is  to  be  accepted  as  the  fair  value  of  the  property  being  con- 
sidered because  the  sum  of  these  two  elements  would  equal  tlu; 
capitahzed  value.  If,  however,  it  is  desired  to  check  the  capi- 
talized value  by  independent  methods,  the  amount  of  going  value, 
as  the  difference  between  the  capitalized  value  and  the  value  of 
the  physical  property,  should  be  determined  and  compared  with 
going  value  as  found  by  the  "deficit"  or  "comparative"  methods. 
The  Privy  Council,  which  generally  corresponds  to  the  Supreme 
Court  in  the  United  States,  has  more  than  once  held  that  the  earn- 
ings of  a  property  must  be  considered  in  determining  going  value. 
The  Hamilton  Gas  Company  of  New  Zealand  was  formed  under 
an  act  which  gave  the  municipality  the  right  to  acquire  the 
property  of  the  gas  works,  upon  paying,  to  use  the  language 
of  the  statute,  what  the  "gas  works  and  plant"  were  worth.  The 
lower  court  found  that  the  commercial  value  of  the  "gas  works 
and  plant"  was,  as  a  going  concern,  the  sum  of  31,382£,  while  if 
valued  in  situ,  excluding  the  idea  of  going  value,  the  property 
was  of  the  value  of  only  13,539£.  The  question  involved  was, 
as  to  which  of  these  two  sums  should  be  paid  by  the  corporation. 
The  company  contended  that  the  price  to  be  paid  for  the  gas 
works  and  plant  "should  be  the  commercial  value  thereof  as  a 
going  concern,"  while  the  Hamilton  borough  contended  that 
"the  price  should  be  merely  the  value  of  the  gas  works  ami 
plant  regarded  as  gas  works  and  plant  in  situ,"  and  that  this 
value  should  be  arrived  at  "by  taking  the  present  value  of  the 
land  and  buildings  and  adding  thereto  what  would  be  the  pres- 
ent cost  of  the  machinery  and  materials  of  a  similar  gas  works 
and  plant  and  of  placing  such  gas  works  and  plant  in  situ,  and 
making  good  the  ground  and  deducting  the  sum  for  deprecia- 
tion." The  Privy  Council  held  unanimously, ^  Lord  Shaw  writ- 
ing the  opinion,  that  the  company  was  entitled  to  be  paid  for  its 

1  Hamilton  Gas  Company,  Limited,  vs.  Hamilton  Corporation,  App.  Cae.  300. 


214  VALUE  FOR  RATE-MAKING 

property  as  a  going  concern,  thereby  awarding  for  going  value 
the  difference  between  £31,382  and  £13,539,  or  £17,834,  or,  as 
stated  in  dollars,  approximately  S89,215,  which  is  132  per  cent, 
of  the  physical  value. 

A  similar  case  settled  by  the  Privy  Council  of  England  from 
Western  Australia  involved  the  same  principle  as  the  preceding 
case.  The  City  of  Perth  had,  under  the  law,  a  right  to  acquire 
the  property  of  the  gas  company  at  the  expiration  of  six  months 
after  serving  notice  of  its  intention  to  purchase  from  the  company 

"all  the  land,  buildings,  hereditaments,  lamps,  pipe,  stock  and  ap- 
purtenances of  and  belonging  to  the  company." 

The  question  was  whether,  in  buying  the  property,  it  was  to  be 
considered  "as  a  going  commercial  concern,"  or  whether  the 
company  was  merely  entitled  to  "the  value  of  the  physical  prop- 
erty" in  place.  The  Privy  Council  reaffirmed  its  ruling^  of  the 
previous  year  in  the  Hamilton  case  cited  above,  and  held  unani- 
mously that  going  values  must  be  allowed  and  that  any  other 
construction  of  the  statute  would  work  great  injustice. 

In  determining  rates  for  competing  steam  or  electric  railroads 
or  other  utilities,  market  value,  that  is,  the  value  fixed  from  a 
consideration  of  earnings,  has  been  used.  The  Public  Service 
Commission  of  the  State  of  Washington  in  finding  the  value  of 
utility  property  is  required  by  statute  to  take  not  less  than 
market  value  as  to  true  value  of  the  property. 

"When  the  commission  shall  have  valued  the  property  of  any  public 
service  company,  as  provided  for  in  this  section,  nothing  less  than  the 
market  value  so  found  by  the  commission  shall  be  taken  as  the  true 
value  of  the  property  of  such  company  used  for  the  public  convenience 
for  the  purpose  of  assessment  and  taxation. "^ 

As  present  "fair  value"  may  be  more  or  less  than  the  present 
"physical  value,"  it  is  evident  that  the  non-physical  or  intangible 
value  should  be  determined  in  connection  with  a  consideration  of 
revenues.  Puljlic  authorities  when  confronted  with  the  problem 
of  fixing  rates  based  on  the  value  of  competing  utility  properties 
have  assumed  the  same  rates  for  both  utilities,  and  occasionally 
fixed  the  rates  high  enough  to  earn  a  return  on  the  larger  capital 
investment,  thus  recognizing  that  the  going  value  in  the  property 
requiring  the  smaller  capital  investment  is  due  to  its  more 
favorable  showing  of  earnings. 

'  Perth  Gas  Company,  Limited,  va.  City  of  Perth  Corporation,  App.  Cas.  (1911)  506. 
'  Washington  Laws,  1911,  ch.  117,  par.  92. 


GOING  VALUE  215 

In  the  Kansas  City  Water-works  case,  tlic  Supivinc  Cuirt 
said : 

"The  city  steps  into  possession  of  a  property  which  not  only  has  the 
abihty  to  earn,  but  is  in  fact  earning.  It  should  pay,  th.-n-fon-.  not 
merely  the  vakie  of  a  system  which  might  be  niade  tu  i-arn.  I.ut  that  of 
a  system  which  does  earn." 

"The  equal  protection  of  the  laws— the  spirit  of  (•(.iiiinun  j,, slice— 
forbids  that  one  class  should  by  law  be  compelled  to  sulTcr  lo.ss  that 
others  may  make  gain.  If  the  State  were  to  seek  to  acquire  the  title 
to  these  roads,  under  the  power  of  eminent  domain,  is  there  any  dowl.t 
that  constitutional  provisions  would  require  the  payment  to  the  cor- 
poration of  just  compensation,  that  compensation  beinir  the  value  of 
the  property  as  it  stood  in  the  markets  of  the  world  and  not  as  pre- 
scribed by  an  act  of  the  legislature?  Is  it  any  less  a  departure  from 
the  obligations  of  justice  to  seek  to  take  not  the  title  but  the  use  for 
the  public  benefit  at  less  than  its  market  value?"* 

The  market  value  theory  as  determining  the  fair  basi.s  of 
value  for  rate-making  recognizes  those  elements  inhering  in  utility 
property  which  cost  or  investment  theory  may  fail  to  take  into 
account.  These  elements  include  favorable  location,  investment 
under  advantageous  market  conditions,  superior  operating  man- 
agement and  business  methods  that  produce  large  revenues  per 
dollar  of  capital  invested.  Consequently,  market  value  has 
many  claims  for  consideration  in  rate-making  and  may  be  well 
used  as  a  guide  and  measure  in  fixing  the  present  "fair  value" 
which  ultimately  may  be  determined. 

If  rates  are  to  be  based  on  physical  cost  alone,  market  value 
means  nothing  other  than  recognition  of  the  rate  at  which  capital 
is  willing  to  invest,  leaving  no  reward  for  the  opciators  of  the 
enterprise.  If  the  rate  of  return  upon  the  investment  is  made 
larger  than  requirements  demand  for  the  safest  investment,  then 
the  market  value  will  l)e  greater  than  the  actual  cost.  On  the 
other  hand,  if  the  rate  of  return  allowed  is  less  than  demaiulrd  by 
current  capital,  then  market  value  v/il!  be  less  than  physical  cost. 
It  is  clear  that  in  a  case  of  a  monopoly  it  is  impossible  to  fi.\  and 
determine  reasonable  rates  purely  from  a  consideration  of  market 
value  which  is  itself  determined  by  the  rates.  On  the  other  hand, 
at  the  time  public  regulation  of  utilities  is  undertaken,  it  nuiy 
be  that  market  value  is  the  proper  point  at  which  fair  present 

1  Reagan  vs.  Farmers'  L  &  T.  Co.,  154  U.  S.  410. 


216  VALUE  FOR  RATE-MAKING 

value  should  be  fixed  as  a  starting  point.  There  is  considerable 
prevalent  opinion  that  market  value  is  the  proper  basis  in  rate 
cases  by  which  to  fix  the  value  even  of  deteriorated  physical  prop- 
erty, that  is,  property  which  has  become  very  largely  theoretic- 
ally depreciated  or  has  reached  a  condition  which  will  soon  require 
renewal. 

Fourth: — Comparison. — Going  value  is  also  used  to  signify  the 
present  worth  of  the  excess  of  earnings  of  an  existing  plant  com- 
pared with  those  of  a  similar  plant,  starting  anew  at  the  date  of 
the  valuation.  For  lack  of  a  better  name  and  because  based 
on  a  comparison,  this  meaning  of  going  value  is  usually  identified 
by  the  term  "comparative  plant"  method.  This  use  of  the  term 
going  value  is  akin  to  its  use  as  applied  to  the  deficit  method, 
for  both  rely  on  the  same  fundamental  fact  for  determining  the 
measure  of  going  value,  namely,  the  cost  of  building  up  the  busi- 
ness and  producing  a  revenue.  In  the  deficit  method,  going 
value  is  usually  fixed  by  a  knowledge  of  the  losses  that  have 
actually  occurred  in  the  past,  in  building  up  the  present  revenue- 
producing  business;  it  is  a  historical  method.  The  comparative 
plant  method  is  strictly  a  reproduction  method,  being  an  estimate 
of  the  cost  of  reproducing  the  present  revenue  of  an  existing  com- 
pany under  present  conditions,  the  same  as  an  estimate  of  the  cost 
of  reproduction  of  the  physical  property  is  made  by  considering  the 
existing  property  constructed  under  present  conditions  at  cur- 
rent costs.  The  deficit  method  of  fixing  going  value  and  the 
original  cost  of  physical  property  are  both  based  on  historical 
investigations,  while  the  comparative  method  of  ascertaining  go- 
ing value  and  the  cost  of  reproduction  of  the  physical  property 
are  based  on  present  costs. 

The  comparative  method  endeavors  to  fix  the  deficit  that 
would  accrue  in  building  up  the  business  and  revenue  of  a  new 
plant  equal  to  the  revenue  and  business  of  the  existing  plant. 
In  determining  the  amount  of  this  deficit  accruing  in  the  com- 
parative plant,  the  same  period  for  construction  of  the  physical 
property  and  the  same  other  premises  are  used  as  are  made  the 
basis  for  fixing  proper  labor  and  material  unit  costs  of  the  phys- 
ical plant  and  in  determining  the  length  of  time  during  which 
interest  and  taxes  will  accumulate,  all  of  which  principles  and 
estimates  are  ordinarily  determined  without  much  controversy  in 
making  up  the  cost  of  reproducing  the  physical  property.  In 
the  same  way,  based  on  similar  knowledge  and  experience  in 


GOING  VALUE  217 

existing  properties,  conclusions  are  reached  as  to  the  period  ..f 
time  required  to  build  up  the  business  and  revenue. 

Explaining  more  in  detail,  it  will  be  seen  that  to  reprochice  the 
revenue  of  an  existing  property,  it  would  tirst  be  necessary  lo 
commence  the  construction  of  a  physical  plant  similar  in  all 
respects  to  the  existing  plant  and,  thereafter,  start  lo  build  up 
the  business  equal  to  the  business  of  the  existing  jiroperty,  a 
process  which  would  take  a  considerable  period  of  time.  liiu8, 
the  same  basis  of  reproduction  cost  of  the  physical  piopcrty  is 
used  as  has  been  obtained  by  the  engineers  nudving  an  inventory 
and  an  appraisal  of  the  existing  ph3'sical  property.  In  the  re- 
duction of  such  physical  property  there  must  be  assumed  a 
gradual  expenditure  for  land,  buildings  and  apparatus,  commen- 
surate with  human  limitations,  as  to  the  rate  at  which  such 
property  can  be  specified,  purchased,  erected  and  gotten  into  a 
condition  for  operation.  This  will  require  some  time,  at  least 
one  open  season  in  smaller  plants  and  several  years  in  larger 
plants.  As  soon  as  sufficient  plant  has  been  constructed,  it  is 
assumed  it  would  immediately  begin  operation  and  service  to 
customers.  The  completion  of  the  physical  plant  and  the  ex- 
tension of  the  business  go  on  as  rapidly  as  possible,  but  as  t  he- 
development  of  business  proceeds  at  a  relatively  slow  rate,  the 
entire  reproduction  of  the  physical  property  will  practicall}-  al- 
ways be  completed  considerablj^  in  advance  of  the  accjuisition 
of  the  revenue.  The  rate  of  acquisition  of  income  is  determined 
from  a  consideration  of  the  business  of  the  existing  company, 
the  rate  at  which  it  has  been  built  up,  the  knowledge  of  local 
conditions  and  experience  in  the  acquisition  of  business  in  other 
similar  properties.  After  a  reasonable  period,  the  gross  revenue 
will  have  been  built  up  to  an  amount  equal. to  that  of  the  existing 
property;  in  the  same  way,  the  operating  expenses  will  gradually 
have  increased  until  they,  too,  equal  those  of  the  existing  com- 
pany. By  comparing  the  figurx^s  of  such  acquisition  of  revenue 
and  increase  in  operating  expenses. of  the  reproduced  property 
with  the  similar- figures  of  the  existing  property,  during  the  period 
necessarily  required  for  the.  reproduction  of  the  physiciil  plant 
and  revenue  of  the  reproduced  property,  the  excess  earnings  may 
be  ascertained.  This  excess,  when  ascertained  year  by  year,  is 
then  discounted  at  a  current  rate  of  interest,  so  as  to  show  the 
value  of  the  excess  earnings  at  the  date  of  the  commencement 
of  the  reproduction  period,  that  is,  at  the  date^of  the  commence- 


218  VALUE  FOR  RATE-MAKING 

nient  of  construction  of  the  physical  property,  which  is  taken  as 
the  date  of  the  valuation,  and  the  sum  of  these  discounted  net 
earnings  of  the  existing  plant — over  those  of  the  reproduced 
plant — is  the  going  value  of  the  existing  plant.  For  a  more 
detailed  explanation  of  this  method  of  determining  the  going 
value  of  an  existing  plant,  the  reader  is  referred  to  the  discussion 
on  going  value  in  the  author's  book,  "The  Valuation  of  Public 
Utility  Properties."^ 

The  comparative  plant  method  of  determining  going  value 
has  been  criticised  because  it  does  not  fix  a  definite  ratio  be- 
tween going  value  and  gross  revenue  or  physical  property. 
Such  criticism  would  seem  superficial,  as  the  ratio  will  depend 
upon  specific  conditions,  for  example,  revenue  and  net  income  of 
a  property  will  be  greater  in  the  case  where  the  investment  has 
been  economically  made  or  where  the  territory  has  been  thor- 
oughly worked,  so  as  to  secure  a  large  amount  of  business  per 
unit  of  investment,  than  in  the  case  where  the  opposite  conditions 
exist.  Again,  the  investment  in  an  electric  plant,  producing 
energy  from  water-power,  will  ordinarily  he  very  much  larger 
than  for  a  plant  with  the  same  capacity  using  fuel  as  the  source 
of  energy.  As  indicating  the  lack  of  relation  between  going  value 
and  revenue  or  property  values,  the  accompanying  tabulation 
is  reproduced,  showing  these  values  in  certain  water-works 
properties,  as  developed  by  Mr.  John  W.  Alvord  of  Chicago. 
The  averages,  below  the  table,  have  been  worked  out  by  the 
author  of  this  volume,  for  the  eleven  cities,  indicated  by  stars, 
that  more  nearly  compare  in  population. 

The  method  has  also  been  criticised  because^  it  always  fixes 
some  going  value,  greater  or  less,  in  all  operating  properties. 
But  is  it  not  evident  that  the  actual  existing  business  of  a  going 
property  is  always  worth  something  more  than  the  mere  physical 
plant?  It  would  cost  something  for  a  new  company  to  secure 
that  same  business,  even  though  the  gross  revenue  were  only  suf- 
ficient to  pay  actual  operating  expenses.  Hence,  it  is  impossible 
for  a  going  property  to  exist  without  having  some  going  value,  al- 
though the  market  value  of  the  entire  property,  including  its 
going  value,  in  the  case  of  sale,  might  be  less  than  the  present 
depreciated  value  of  the  physical  property  alone.  The  non-suc- 
cess of  a  utility  as  a  paying  property  docs  not  demonstrate  there 
is  no  going  value  any  more  than  the  existence  of  such  property 

1  See  page  152,  "The  Valuation  of  Public  Utility  Properties,"  by  Henry  Floy. 


GOING  VALUE 


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220  VALUE  FOR  RATE-MAKING 

demonstrates  the  ph^-sical  plant  is  worth  what  it  may  have  cost 
or  what  it  may  now  appraise  for.  An  investor  will  always  be 
willing  to  pay  a  bonus  for  an  established  business  as  compared 
with  buying  the  structural  property  without  such  business,  be- 
cause in  the  latter  case  it  will  cost  something  additional  to  create 
an  established  business.  The  total  price  the  investor  will  be 
willing  to  pay  for  the  structural  property,  plus  the  established 
business,*  is  only  such  as  will  afford  him  a  satisfactory  return, 
present  or  prospective;  consequently,  the  value  to  him  may  or 
may  not  be  greater  than  the  original  investment  or  the  appraised 
value,  depending  upon  the  revenue  obtainable  and  the  cost  of 
operation,  but  in  any  case  some  part  of  the  total  value  is  rep- 
resented by  going  value. 

The  comparative  plant  method  has  been  criticised  because 
the  results  "rest  upon  certain  basic  assumptions  as  to  the  rate  of 
construction  of  the  physical  plant,  the  rate  of  recovery  of  the 
earnings,  and  the  rate  of  increase  of  operating  expenses."* 
There  is  no  question  but  what  the  method  rests  upon  "certain 
basic  assumptions,"  the  result  of  expert  opinion,  but  where 
assumptions  are  based  on  reliable  expert  opinion,  the  courts  have 
held  the  conclusions  reached  are  a  safe  basis  upon  which  to  fix 
values.  The  assumptions  made  as  to  the  rate  of  construction  of 
the  physical  plant  are  the  same  as  those  used  in  ascertaining  the 
cost  of  reproduction  of  the  physical  property,  which  is  not 
generally  criticised,  at  least  as  to  principle.  The  rate  of  recovery 
of  earnings  can  be  fairly  definitely  established  for  any  particular 
property  by  a  study  of  local,  historical  conditions  and  a  knowledge 
of  the  experience  of  similar  plants.  The  rate  of  increase  of 
operating  expenses  can  be  very  definitely  determined  when  the 
rate  of  recovery  of  earnings  is  fixed  and  from  a  knowledge  of  the 
output  and  analysis  of  the  existing  operating  expenses. 

At  first  thought  it  would  seem  as  if  the  comparative  plant 
method  was  used  to  "argue  in  a  circle,"  in  that  present  revenues, 
based  on  existing  rates,  are  employed  in  order  to  determine  the 
going  value  of  part  of  the  principle  upon  which  fair  return  is  to 
be  allowed.  To  a  limited  extent  this  criticism  is  fair,  but  it  will 
be  easily  recognized  that  if  the  existing  rates  are  assumed  to  be 
excessive  by  some  arbitrary  amount,  say  10  per  cent,  or  20  per 
cent.,  the  total  revenue  of  the  existing  plant  can  be  reduced  by  the 
amount  of  the  arbitrary  percentage  assumed  and  going  value 

'  City  of  Greenbay  vs.  Greenbay  Water  Company,  11  W.  R.  C.  R.  245. 


GOING  VALUE  221 

figured  on  that  basis.  Such  proccchnc  will  ordinarily  show  that 
the  amount  of  going  value  determined  by  the  use  of  the  existing 
rates  is  but  little  in  excess  of  the  going  value  as  found  l)y  arbi- 
trarily reducing  the  revenues  a  moderate  amount.  In  fact, 
going  value  will  be  found  to  exist  in  a  very  substantial  amount [ 
with  the  ordinary  property,  even  though,  as  an  extreme;  assump- 
tion, revenues  are  assumed  and  taken  to  be  only  such  an  amount 
as  will  provide  for  operating  expenses  including  taxes  and  depre- 
ciation and  a  fair  return  on  the  value  of  the  physical  pioix-rty. 
It  must,  of  course,  be  recognized  that  the  comparative  plant 
method  is  to  be  used  fairly  and  logically  in  assisting  the  judg- 
ment to  determine  a  reasonable  amount  for  going  value;  the 
method  cannot  be  applied  without  sense  or  reason,  merely  as 
a  mathematical  performance,  in  working  out  to  the  last  decimal 
point  a  figure  which,  beyond  controversy,  can  be  held  as  an  abso- 
lute measure  of  going  value. 

Criticism  of  the  comparative  plant  method  has  been  made  un 
the  grounds  that  with  the  physical  property  entirely  complete, 
the  business  of  the  customers  and  revenue  of  the  utility  would 
immediately  be  attached  and  developed.  As  a  practical  matter 
such  is  not  the  case.  To  any  one  unacquainted  with  the  details  of 
utility  business,  the  rate  of  development  is  surprisingl}'  slow  and 
the  lethargy  and  antipathy  of  the  non-user  is  incomprehensible^ 
although,  of  course,  much  depends  upon  the  character  of  the  local 
community.  It  is  difficult  for  the  uninitiated  to  conceive  of  a 
city  without  a  public  water  supply,  for  example,  where  the  addi- 
tion of  consumers  and  the  development  of  the  business  would  not 
be  practically  as  rapid  as  the  progress  of  construction  of  the 
physical  property.  But  such  is  by  no  means  the  case  even  with  a 
utility  providing  such  a  necessity  as  water,  and  in  the  case  of 
utilities  furnishing  transportation,  gas  or  electric  energy,  the 
development  of  the  business  is  very  much  less  rapid  than  in  the 
case  of  water.  A  most  excellent  illustration  of  this  truth  is 
shown  by  the  history  of  the  installation  and  development  of  the 
city  water-works  system  in  New  Orleans,  La.  This  city  now 
has  a  population  of  360,000,  but  in  1908  it  had  no  public  water- 
works system  of  its  own  and  only  an  inadequate,  privately 
owned  plant,  in  the  hands  of  a  receiver.  The  construction  of  the 
city's  waterworks  was  begun  in  1905  and  sufficiently  completed 
three  years  later  to  begin  furnishing  WMter,  the  sui)i)ly  of 
water   being   taken   from   the   Mississippi   River.     Up   to  that 


222  VALUE  FOR  RATE-MAKING 

time  the  citizens  were  depending  largely  upon  tanks  in  which 
rain  water  was  stored  or  in  some  comparatively  few  instances 
upon  wells.  The  city  has  constructed  a  complete  modern  water- 
works system  at  an  expense  of  approximately  $9,000,000,  in- 
cluding pinnp  works,  equipment  for  sedimentation,  coagula- 
tion and  filtration,  a  distribution  system  containing  547  miles  of 
pipes  covering  the  populated  districts,  and  the  property  is  now 
in  a  position  to  supply  all  demands  with  a  first  class  quality  of 
water.  In  spite  of  the  construction  of  the  new  municipal  works 
and  the  availabilitj^  of  a  copious  supply  of  potable,  pure  water 
the  citizens  did  not  connect  their  premises  and  in  order  to  compel 
the  citizens  to  take  water  from  the  municipal  system  promptly, 
an  ordinance  was  adopted  by  the  authorities  on  July  13,  1911, 
under  which  the  Water  Board  was  given  authority  to  notify 
individual  householders  that  they  must  connect  with  the  water- 
works system  within  90  days  of  the  said  notice,  and  in  case  of 
failure  to  complj^  with  said  notice  the  property  owner  was  subject 
"to  a  fine  not  exceeding  $25,  or  to  imprisonment  not  exceeding 
thirty  (30)  days,  or  both,  at  the  discretion  of  the  Court,  for  each 
day  thereafter."  In  case  of  continued  default,  upon  further 
written  notice  requiring  compliance  within  10  days  additional, 
then  the  Board  was  given  power  "to  do,  or  cause  to  be  done, 
upon  the  defaulting  premises,  that  which  its  ordinances  and 
regulations  require,  at  the  cost  and  expense  of  the  owner,  and 
such  cost  and  expense  shall  be  a  lien  on  said  premises  equal  in 
rank  to  the  lien  of  the  taxes,  to  take  effect  as  to  third  persons  on 
the  recording  in  the  Mortgage  Office  of  the  bill  therefore,  *  *  *." 
This  general  line  of  procedure  has  been  duly  followed  since, 
with  the  result  that,  in  round  numbers,  67,000  buildings  have 
been  connected  out  of  the  total  75,000  buildings  now  estimated 
in  the  City  of  New  Orleans.  In  connection  with  this  matter,  a 
statement  from  the  report  of  the  General  Superintendent,  Mr. 
Earle,  submitted  to  the  Board  Oct.  14,  1915,  is  of  interest: 

"Forced  Connections. — Continued  progress  has  been  made  in  serv- 
ing of  notices  on  property  holders  to  connect  with  the  sewerage  and 
water-works  systems.  To  date  a  total  of  7,556  notices  have  been 
served,  of  which  6,038  have  been  complied  with,  and  168  on  which  the 
90  days  limit  of  time  has  not  yet  expired." 

The  unwillingness  of  the  citizens  to  take  pure  water  exists 
despite  the  local  conditions,  namely: 

First. — The    large  number  of    buildings   supplied  only  from 


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aOINd   VALUE  22:i 

tanks  or  cisterns  witli  rain  water  of  nnceitaiii  purity  arni  varialdc 
in  amount. 

Second. — The  desirability  of  doin^  away  with  tanks  aixl 
cisterns,  which  very  lar^jely  contributed  to  the  continuatiun  nf 
the  annual  plague  of  yellow  fever  which  formerly  i)revailcd  in  New 
Orleans. 

Third. — The  attractiveness  and  healthfulness  ot  a  niuinripid 
supply  of  first  class  water  at  reasonably  low  rates. 

Fourth. — The  local  strong  sentiment  favoring  the  use  of  water 
supplied  by  the  municipality  and  demanding;  cooperatinii  .iii.I 
support  of  a  great  public  work. 

Fifth. — The  active  enforcement  of  the  ordinances  and 
regulations  providing  for  the  connection  of  each  and  every  liouse 
in  the  City  with  the  municipal  water  supply. 

The  surprising  tardiness  and  natural  reluctance  of  the  average 
citizen  to  change  his  existing  mode  of  living,  is  completely 
evidenced  in  the  record  shown  by  the  curves  on  the  follow- 
ing page,  indicating  the  slow  progress  made  in  substituting  a  pure 
and  copious  supply  of  water  for  the  old  sources  of  supply.  The 
growth  of  the  business,  shown  by  the  accompanying  curves,  re- 
produced from  a  diagram  in  the  annual  report  of  the  Sewerage 
and  Water  Board  of  New  Orleans,  for  the  year  ending  Jan.  1, 
1915,  extended  to  1916  by  the  writer,  from  data  secured  from 
the  Department,  indicates  the  growth  of  the  business  by  the 
number  of  services  and  meters  each  year,  from  the  time  the  water- 
works began  supplying  water  in  July,  1908,  up  to  the  present 
time.  It  will  be  noted  that  the  number  of  services  in  use  has 
increased  at  a  very  uniform  rate  and  that  the  completed  construc- 
tion of  the  physical  plant  and  its  ability  to  supply  water  to  all 
users,  has  not  had  very  much  to  do  with  the  rate  at  which  the 
consumers  are  willing  to  take  up  with  a  new  proposition  and  use, 
even  so  necessary  a  commodity  as  water. 

The  total  house  connections,  including  fire  services,  up  to  Jan. 
1,  1916  were  41,037,  that  is,  one  connection  for  8.8  inhabitants 
compared,  for  example,  with  8.2,  found  by  the  Wisconsin  Com- 
mission, as  an  average  for  Wisconsin  towns.  By  reason  of  the 
difference  in  conditions  existing  before  and  after  the  city  water- 
works was  built,  and  because  of  the  existing  ordinance  requiring 
the  taking  of  city  water,  it  would  seem  as  if  a  water-works  system 
in  New  Orleans,  if  anywhere,  would  show  a  very  rapid  increase 
in  the  number  of  consumers  and  yet  the  contrary  is  the  fact. 


224 


VALUE  FOR  RATE-MAKING 


The  reluctance  of  the  average  citizen  to  become  the  user  of 
public  utility  service  is  almost  inexplicable,  and  has  been  the 
cause  of  frequent  and  calamitous  loss  to  investors  in  public 
utility  corporations.  The  following  table,  giving  the  actual 
results  obtained  in  certain  water-works  properties  is  pertinent. 

Table   VII. — Showing  the   Time   Required  for  Water-works  Plants 
TO  Acquire  One  Dollar  per  Capita  of  Domestic  Revenue 

Prepared  by  the  late  Mr.  Benezette  Williams.     (From  Proceedings  of  the  American  Water- 
works Association,  1909,  page  250.) 


Domestic  revenue  in 
dollars  and  population 


Years  to  acquire  one 
dollar  per  capita 


Appleton,  Wis 

Eau  Claire,  Wis. .  r-.  . 

Sheboygan,  Wis 

Galena,  Kansas 

Hornelsville,  N.  Y... 

Flint,  Michigan 

Dubuque,  Iowa 

Beloit,  Wis 

Ludington,  Michigan 

Warren,  Ohio 

Salina,  Kansas 


16,700 

18,000 

20,000 

4,700 

11,000 

10,200 

36,300 

9,000 

8,000 

7,200 

5,.500 


21 

15 

6 

8 


29 
12 

10 
7.5 

12 


Unwarranted  presumptions  sometimes  made  by  public  utility 
commissioners  or  judges  of  court  that  the  "comparative  plant" 
method  of  estimating  going  value  is  "guess  work,"  "mere  opin- 
ion," "unreliable  estimates,"  etc.,  are  in  many  cases  entirely 
unwarranted  and  indicate  a  lack  of  appreciation  of  the  compli- 
cated facts,  data  and  experience  necessarily  included  in  making  up 
such  estimates  which  are  in  most  cases  based  upon  a  knowledge  of 
conditions  in  similar  or  like  plants,  modified  by  the  judgment  of 
the  expert  in  its  application  to  the  existing  conditions. 

The  comparative  plant  method  has  been  criticized  because  it 
takes  into  account  the  business  of  the  existing  plant  in  the  im- 
mediate future.  But  such  criticism  would  seem  unfair  because 
the  estimate  of  the  business  in  the  immediate  future  is  based  on 
the  facts  as  to  the  immediate  past.  Moreover,  it  would  be  illog- 
ical to  determine  present  going  value  upon  the  assumption  that 
the  value  should  have  been  anticipated  by  a  period  of  years. 
For  example,  if  a  city  is  purchasing  property  as  of  Jan.  1,  1916, 
and  going  value  is  figured  as  of  that  date,  it  would  be  illogical  to 
assume  that  the  city  might  have  begun  building  the  comparative 


GOING  VALUE 


225 


property  five  or  six  years  earlier,  before  any  decision  \v;is  made  t(. 
own  such  property,  and  accept  such  vahie  ns  prcjpcr  prcs^cnt 
going  value.  The  question  is  whether  the  property  was  to  ho 
taken  as  of  Jan,  1,  1910,  and  if  so,  what  the  city  couhl  afTord  to 
pay  on  that  date,  not  what  they  could  afford  to  pay  if  they  had 
decided  several  years  previously  to  purchase  that  projMTty. 
Moreover,  the  dating  back  of  going  value  would  not  very  materi- 
ally reduce  the  amount  of  same,  as  it  would  be  effected  only  l)y 
the  increase  of  future  revenue  over  the  present,  which  increase  is 
usually  a  relatively  small  percentage  of  the  existing  revenue. 

A  modification  of  the  deficit  and  comparative  i)lant  methods 
has  been  used  by  the  Railroad  Commission  of  Wisconsin,  and 
was  first  published  in  the  decision  in  the  Milwaukee  Gas  Light 
Company  case.  The  method  consists,  in  general,  in  using 
such  value  of  the  physical  property  to  start  with  as  is  estimated 
to  be  required  to  begin  furnishing  service  and,  from  year  to 
year,  adding  to  such  property  value,  additions,  allowance  for 
fair  return,  operating  expenses  and  the  necessary  amount  for 
depreciation,  then  deducting  from  the  sum  the  annual  revenue, 
thereby  getting  a  value  which  is  called  plant  value  that  repre- 
sents the  total  cost  of  plant  and  business  at  the  end  of  each  year. 
If  from  this  cost  of  plant  and  business,  as  found  for  any  year,  there 
is  deducted  the  value  of  the  physical  plant  and  its  additions 
at  the  end  of  such  year,  the  result  is  the  cost  of  development  of 
the  business  up  to  the  end  of  that  year. 

Table  VIII. — Cost  of  Development  of  Business^ 

Milwaukee  Gas  Lij^ht  Company. 


1       1st  year 

2n(l  year 

3rd  year 

4th  year 

Cost  of  plant,  January  1st 

Additions 

$9,000,000 
500,000 
630,000 
17,.500 
660,000 
160,000 

$10,005,220 
300,000 
700.365 
10,500 
989,000 
170,000 

$10,498,385 

250,000 

723,887 

8.750 

1.131,000 

180,000 

$10,688,922 
100,(XX) 
748.225 

Interest  on  additions  for  \i  year.  . 

3.. 500 
1.265,400 

Depreciation 

190,000 

Total  cost 

$10,967,500 
962,280 

$12,175,085 
1,676,700 

$12,803,022 
2,114.100 

$12,990,047 
2.414,250 

Plant  value,  Dec.  31 

$10,005,220 

$10,498,385 

$10,688,922 

$10,581,797 

Cost  of  developing  business  end 
of  year 

505,220 
1,320,000,000 

698,385 
2,300,000,000 

638.922 
2.900,000,000 

431.797 
3.330,000,0<X) 

iCity  of  Milwaukee  vs.  Milwaukee  Gas  Light  Co.,  12  W.  H.  C.  K.  402. 
15 


226  VALUE  FOR  RATE-MAKING 

As  seen  by  reference  to  the  accompanying  table,  the  plant  value 
as  found  at  the  end  of  the  first  year  is  carried  forward  as  the 
value  of  the  property  at  the  beginning  of  the  second  year,  to 
which  amount  the  value  of  additions  to  structural  property, 
fair  interest  charges,  operating  expenses,  necessary  allowance  for 
depreciation  are  added  and  from  the  sum  is  deducted  the  esti- 
mated annual  revenue  for  the  second  year,  thus  getting  the  total 
cost  of  plant  and  business  at  the  end  of  the  second  year;  deduct- 
ing from  this  sum  the  total  cost  of  plant  and  its  additions  up  to 
the  end  of  that  year,  the  remainder  will  be  the  cost  of  develop- 
ment up  to  the  end  of  the  year.  The  property  cost  at  the  end 
of  the  second  year  is  then  carried  forward  and  forms  the  base  to 
which  are  added  the  additions  and  charges  for  the  third  year, 
with  deduction  for  gross  revenue.  This  process  is  continued  for 
several  years,  usually  from  four  to  six  years,  covering  a  period 
in  which  it  is  estimated  the  business  can  be  built  up  to  a  point  at 
which,  under  normal  conditions,  revenues  are  sufficient  to  pro- 
vide a  fair  return  upon  the  property,  as  well  as  depreciation  and 
operating  expenses.  From  the  property  value,  as  found  for  the 
last  year,  is  deducted  the  total  value  of  plant  and  additions,  the 
remainder  being  the  cost  of  developing  the  business  at  the  time 
the  property  is  assumed  to  be  upon  a  paying  basis,  and  therefore 
the  said  cost  of  development  represents  the  going  value  which 
must  be  added  to  the  value  of  the  plant  in  order  to  ol)tain  the 
total  value  of  the  property,  since  interest  during  construction  is 
included  in  the  value  of  the  physical  property,  and  all  operating 
expenses,  including  taxes  and  depreciation,  together  with  a  fair 
return  on  the  entire  investment  are  cared  for  in  the  computation 
made  along  the  above  lines.  Criticism  of  this  method,  the  same 
as  of  the  strict  comparative-plant  method,  may  he  made  on  the 
grounds  that  actual  revenue  in  place  of  "fair  revenue"  is  used 
in  the  calculations.  It  has  been  suggested  that  the  criticism 
can  be  avoided  by  substituting  x  for  the  final  ''fair  revenue" 
and  a  fraction  or  percentage  of  x  for  the  different  preceding 
years,  then  solving  for  x,  which  when  found  and  capitalized  at 
the  "fair  rate  of  return"  assumed  will  give  the  actual  fair  value 
of  the  entire  property,  including  going  value. 

It  will  be  seen  the  above  method  of  estimating  going  value 
which  has  been  used  and  apparently  approved  by  the  Wisconsin 
Commission  is,  like  the  comparative  plant  method,  based  on  the 
value  of  the  plant,  assumptions  as  to  the  time  required  for  its 


GOING  VALUE  227 

construction,  interest  charges,  taxes,  estimates  as  to  growth  and 
development  of  the  business  and  revenue  extending  over  future 
period  of  time  considered  necessary  to  put  the  property  on  a 
basis  where  it  will  earn  all  operating  expenses,  depreciation 
allowances  and  a  fair  return. 

In  addition  to  the  Wisconsin  Commission,  the  Railroad  Com- 
mission of  California  has  approved  the  use  of  the  comparative 
plant  method  in  the  following  language: 

"The  engineers  for  the  defendant  have  estimated  a  'going  concern 
cost'  or  'development  expense'  for  this  system  amounting  to  $212,100. 
The  computation  by  which  this  is  derived  assumes  building  an  identical 
plant  and  is  derived  by  the  following  method,  as  set  out  in  the  engineers' 
report : 

'The  sum  of  the  annual  excess  in  net  returns  of  the  existing  plant  over 
the  comparative  plant,  in  the  period  of  years  from  the  taking  to  the  time 
when  the  earnings  of  the  comparative  plant  are  assumed  to  become 
identical  with  those  of  the  existing  plant,  represents  the  development 
expense  of  the  existing  plant.' 

"If  applied  to  a  fair  period  and  based  on  accurate  data,  this  method 
becomes  an  approximate  measure  of  the  amount  of  losses  sustained  in 
bringing  the  plant  to  a  paying  basis. "^ 

The  Supreme  Court  of  Wisconsin  has  recently  rendered  a  pecu- 
liar decision  in  which  it  took  the  position  that  the  value  of  the 
property  of  the  Oshkosh  Water-works  Company  as  found  by  the 
Wisconsin  Commission  at  $525,000  was  correct,  on  the  ground 
that: 

"One  thing  is  evident.  The  Commission  either  allowed  $54,000  for 
reproduction  cost  of  paving  not  disturbed,  and  about  $14,000  for  going 
value  in  their  final  award,  or  else  they  disregarded  the  item  of  $54,000, 
and  allowed  $68,000  for  going  value. 

"An  ehmination  of  the  item  $54,000  results,  as  before  stated,  in  an 
allowance  of  about  $68,000  for  going  value.  Under  the  evidence  such 
sum  is  reasonably  adequate.  If  the  Commission  erred  in  allowing  only 
$14,000  for  going  value,  such  error  was  cured  by  its  allowance  of  $54,000 
for  reproduction  cost  of  paving  not  disturbed.  If  it  did  not  allow  the 
$54,000  item,  then  it  allowed  $68,000  for  going  value.  In  either  case  the 
plaintiff  was  not  prejudiced.'"' 

'  Report  of  decisions  of  the  Railroad  Comrnission  of  California,  Thonias  ^^onahatl,  as 
Mayor  of  tiie  City  of  San  Jose  vs.  Sao  Jose  Water  Company,  Case  No.  470,  decided  May 
22,  1914  (Decision  .No.  1534.  pages  14  and  lo). 

^Oslikosh  Water-works  Co.  vs.  Railroad  CommissioD  of  Wiscopsin,  152  .N.  W.  859, 
R.  U.  R.  1915,  D  342,  4. 


228  VALUE  FOR  RATE-MAKING 

Going  Value  not  Plant  Operation. — The  term  "going  value" 
is  sometimes  used  in  ignorance  or  disingenuous!}'  to  indicate 
that  the  physical  plant  is  working  and  going  in  the  sense  that  the 
physical  elements  are  performing  the  functions  for  which  they 
were  installed.  This  latter  adaptation  of  the  term  "going"  to 
the  physical  plant  is  entirely  misleading  and,  as  is  evident,  no 
additional  value  above  the  cost  of  complete  construction,  accrues 
to  the  structural  property,  pei'  se,  simply  because  the  machinery 
is  in  motion  and  the  plant  used  instead  of  being  allowed  to  re- 
main inactive.  Considering  a  new  property  the  cost  of  the 
physical  plant  complete  before  operation  began  would  be  iden- 
tical with  the  fair  present  value  of  the  same  plant  the  following 
day  when  it  was  put  into  full  operation  if  going  value  means 
nothing  more  than  operation. 

Some  authorities  have  used  going  concern  as  distinct  and  sepa- 
rate from  going  value,  apparently  indicating  by  going  concern, 
the  fact  that  the  plant  is  in  operation  and  therefore  going  con- 
cern would  mean  the  same  as  going  value  under  the  erroneous 
definition  of  the  preceding  paragraph.  Going  concern  and  going 
value  arc  usually  intended  to  cover  the  same  item  of  property 
value,  namely,  that  intangible  element,  not  being  represented  by 
physical  property,  which  results  in  addition  to,  but  in  connection 
with  the  structural  property  when  the  latter  is  being  used  so  as 
to  yield  a  revenue. 

Going  value  as  meaning  nothing  more  than  the  operation  of 
the  physical  propert}'  has  been  definitely  and  specifically  urged 
by  public  authorities  and  is  disapproved  by  courts.  A  very  re- 
cent case  of  this  kind  is.  that  of  the  Kings  County  Lighting  Com- 
pany, where  the  Public  Service  Commission  of  New  York,  First 
District,  speaking  through  its  chief  counsel  says: 

"Aside  from  earning  power;  however,- one  may  not  doubt  that  in 
a  rate  case  the  Inisiness  or  the  plant  in  which  the  several  parts  have 
been  gathered  together,  in  orieplace,  connected  aiid  put  in  operation, 
may  have  value.  It  is  assumed,  of  course,  that  the  operation  is  not 
merely  experimental  and  that  the  business  or  the  plant  has  been  gathered 
not  in  a  wihlerncss  but  in  some  place  where  there  is  demand  for  its 
service.  If  this  be  not  the  fact,  then  the  business  or  the  plant  is  not 
worth,  even  its  construction  cost  and  may  possibly  have  no  value 
whatsoever.  Giving  the  plant  any  value  implies  necessarily  that  it  is 
working  and  going  to  some  extent. "^ 

'  Brief  of  Hon.  Goo.  S.  Coleman,  Counsol  of  the  Public  Service  Commission,  of  the  First 
Distriit,  before  tlie  Court  of  Appeals,  in  the  State  of  New  York,  page  27. 


GOING  VALUE  229 

The  eminent  counsel  in  this  case  apparently  fails  to  appreciate 
the  difference  between  "the  business"  and  "the  plant."  Evi- 
dently he  would  not  allow  any  value  to  a  physical  plant  which 
had  been  newly  completed  ready  for  business  but  had  never 
turned  a  wheel  because  he  says,  "Giving  the  plant  any  value 
implies  necessarily  that  it  is  working  and  going  to  some  extent." 
This  attitude  of  mind  of  counsel,  supports  the  opinion  of  the 
Commission  in  the  same  case,  as  shown  by  the  following  state- 
ment: 

"Throughout  the  appraisal  the  plant  has  been  treated  as  a  'going 
concern.'  The  property  has  not  been  valued  as  a  defunct  or  static 
concern.  If  it  had  been,  the  value  would  be  very  much  lower  than  the 
amount  fixed. "^ 

It  would  be  interesting  to  know  what  difference  in  value  this 
or  any  other  commission  would  make,  between  the  value  of  a 
newly  completed  "static"  plant,  and  that  same  plant  "going." 
It  will  be  noted  that  "going  concern"  is  used  in  connection  with 
the  physical  property  whereas  the  term  properly  relates  to  the 
business  and  the  establishment  of  revenue  which  is  entirely  dis- 
tinct from  the  construction  of  a  structural  plant. 

The  Public  Service  Commission  of  the  State  of  Missouri,  in  a 
recent  decision,  has  fallen  into  the  same  error,  stating: 

"The  Commission  will  not  attempt  to  fix  a  separate  and  distinct 
item  for  going  value  in  this  case,  as  contended  for  by  defendants,  but 
will  take  'into  account,  the  fact  that  the  plant  was  in  successful  opera- 
tion' as  a  going  concern. "^ 

The  attitude  of  certain  public  authorities  in  declining  to  allow 
a  separate  item  for  going  value  is,  no  doubt,  in  part  due  to  the 
loose  use  of  the  term  "going  value"  and  "going  concern  value" 
by  the  courts,  the  contrary  opinions  and  decisions  of  judges  and 
courts  themselves,  due  to  failure  to  understand  all  the  elements 
that  go  to  make  up  utility  property. 

Going  value  is  just  as  definite  and  essential  a  part  of  the  cost 
of  establishing  the  revenue,  as  is  engineering,  lawyers'  fees,  in- 
terest on  investment,  taxes,  etc.,  a  part  of  the  cost  of  establishing 
physical  property  of  a  public  utility. 

'  p.  S.  C.  R.  of  New  York,  First  District,  Vol.  II,  page  694. 

"^  Decision  of  Public  Service  Commission  of  the  State  of  Missouri,  rendered  June  23,  1914, 
McGregor-Noe  Hardware  Company  et  al.  vs.  Springfield  Gas  &  Electric  Co.  etc.,  Reports 
Vol.  I,  page  526. 


230  VALUE  FOR  RATE-MAKING 

Both  the  Supreme  Court  and  the  Higher  Court  of  Appeals, 
of  the  State  of  New  York,  have  definitely  negatived  the  claim  of 
the  Public  Service  Commission  of  New  York,  First  District,  and 
its  counsel,  that: 

"going  concern  value  as  a  separate  item  in  tlie  valuation  of  a  property 
in  the  rate  case  was  not  to  be  ascertained,  allowed  and  added  to  the 
value  of  the  structural  property."' 

Judge  Clark,  quoting  with  approval  the  Supreme  Court's  de- 
cision in  the  Omaha  Water  Company,  the  National  Water-works 
Company,  Knoxville  W^ater-works  Company,  and  the  Cedar 
Rapids  Gas  Company  cases,  and  others,  held  that  the  New 
York  Commission's  decision  showed  on  its  face  it  had  not  prop- 
erly allowed  for  going  value  in  determining  fair  value,  simply 
because  the  physical  property  was  being  used  rather  than  allowed 
to  stand  idle.  The  Commission's  basis  of  considering  going 
value  does  not  add  one  dollar  to  the  cost  of  the  physical  prop- 
erty, completed  and  ready  for  service,  whereas  it  is  common 
knowledge  that  it  costs  additional  time,  effort  and  money  to 
obtain  business  and  produce  a  revenue.  This  fact  is  clearly 
recognized  by  Judge  Miller  of  the  Court  of  Appeals,  which  court 
sustains  Judge  Clark's  decision,  and  passing  on  the  method 
followed  by  the  Commission  says: 

"The  Commission  in  this  case  says  it  was  taken  into  account  in 
valuing  the  plant  as  a  'going'  and  not  a  'defunct'  or  'static'  concern 
and  that  it  was  also  considered  in  fixing  the  fair  rate  of  return.  The 
Appellate  Division  says  that  there  is  no  proof  of  the  latter  fact  in  the 
record.  Thus  the  first  question  certified  required  us  to  decide  whether 
'going  value'  is  to  be  appraised  as  a  distinct  item,  or  whether  it  is 
sufficient  to  regard  it  as  something  vague  and  indefinable  to  be  given 
some  consideration  but  not  enough  to  be  estimated.  The  valuation  of 
the  physical  property  was  determined  by  ascertaining  the  cost  of  re- 
production less  accrued  depreciation.  Preliminary  and  development 
expense  prior  to  operation  were  included,  but  no  allowance  was  made 
for  the  cost  of  developing  the  business.  By  tliat  metliod,  the  plant 
was  valued  in  a  sense  as  a  'going  concern,'  in  other  words,  'scrap' 
values  were  not  taken;  but  to  say  that  that  sufficiently  allows  for 
'going  value'  is  the  same  as  to  saj'  that  'going  value'  is  not  to  be 
taken  into  account." 

*  *  *  "It  would  have  been  entitled  to  a  return  on  the  valuation 
adopted   by   the  Commission  if   it   had  no  customers,    but   was  just 

'  Brief  of  Hon.  Geo.  S.  Coleman,  Counsel  of  the  Public  Servioe  Commission  of  the  First 
District,  before  the  Court  of  Appeals  in  the  State  of  New  York,  page  27. 


GOING  VALUE  231 

ready  to  begin  business,  whereas  it  had  a  plant  in  operation  witli  an 
established  business,  which  every  one  knows  takes  time,  lal)or  and 
money  to  build  up."  *  *  * 

"Manifestly  a  rate  computed  on  the  cost  to-day,  reproducing  the  fair 
j)lant  would  not  be  fair.     Experience  is  proverbially  expensive."   *  *  * 

"The  term  'going  value'  though  not  exactly  defined,  has  been  used 
quite  generally  to  comprise  the  elements  not  included  in  the  structural 
value  of  the  property  in  its  present  condition.  The  term  is  not  im- 
portant. The  point  is  that  in  some  manner  and  under  some  property 
heading  a  due  allowance  must  be  made  for  the  investment  in  tliose 
elements. "1 

Going  Value  not  Rate  of  Return. — Some  theorists  argue  that 
going  value  cost  should  be  paid  off  out  of  earnings  and  not  allowed 
as  a  part  of  the  capital  value  of  the  property.  Such  procedure  is 
desirable  where  practicable,  as  would  be  the  logical  carrying  out 
of  that  theory  to  its  fair  conclusion,  namely,  that  the  cost  of  the 
physical  plant  should  also  be  paid  off  out  of  earnings  so  that  the 
entire  utility  property  would  have  no  outstanding  value  and 
rates  could  justly  be  fixed  by  being  based  only  upon  operating 
expenses,  including  management,  taxes  and  depreciation.  Such 
regulation  will  absolutely  "safeguard  the  actual  investment  of 
the  security  holders  and  reduce  the  cost  of  production  and  the 
rate  of  charge." 

The  trouble  with  these  theories  is  that  while  they  may  be  ideal 
they  are  impracticable.  This  is  well  illustrated  by  the  following 
arguments  advanced  in  a  recent  paper. - 

"The  better  way  is  to  forego  dividends  until  earnings  are  adequate 
to  cover  ordinary  operating  expenses,  cost  of  securing  new  business,  and 
interest  on  bonds.  *  *  *  Public  policy  with  relation  to  public  utility 
rates  cannot  be  limited  by  an  estimate  of  cost  to  a  particular  consumer 
at  a  particular  moment.  Public  policy  will  look  to  the  future  as  well 
as  to  the  present  and  adopt  the  rate  policy  that  offers  the  largest 
measure  of  public  advantage  even  though  the  chief  advantage  be  secured 
by  future  consumers  rather  than  by  those  of  the  present.  The  rate- 
paying  public  can  well  afford  to  bear  the  temporary  extra  cost  of 
amortizing  all  intangible  and  questionable  elements  of  capital  cost. 
This  will  tend  to  safeguard  actual  investment  of  the  security  holders 
and  to  reduce  the  cost  of  production  and  the  rate  of  charge." 

1  Court  of  Appeals,  State  of  New  York,  in  The  People  ex  rel.  Kings  County  Lighting 
Company  vs.  Wilcox  et  at,  composing  Public  Service  Commission,  First  District,  Mar.  24, 
1914,  210  N.  Y.  479. 

^  "Principles  of  Valuation"  by  R.  H.  Whitten,  The  Annals  of  American  Academy  of  Political 
and  Social  Science,  May,  1914,  page  194. 


232  VALUE  FOR  RATE-MAKING 

Under  ordinary  circumstances,  investors  cannot  be  induced 
to  tie  up  their  capital  with  the  expectation  that  they  shall  be 
compelled  to  go  without  earnings  in  order  to  amortize  any 
considerable  part  of  the  investment  necessary  for  creating  the 
property  and  "forego  dividends  until  earnings  are  adequate  to 
cover  operating  expenses,  cost  of  securing  new  business  and 
interest  on  bonds."  The  return  upon  capital  is  not  and  cannot 
be  controlled  by  arbitrary  rules.  Free  capital  cannot  be  com- 
pelled to  invest  by  statute.  Unless  regulating  bodies  recognize 
the  economic  laws  which  control  the  local  rate  of  return  demanded 
})y  investors,  free  capital  cannot  be  induced  to  enter  the  particular 
enterprise  under  consideration.  If  investors  are  to  be  forced  to 
go  witiiout  their  dividends  in  order  to  amortize  some  part  of  the 
proper  capital  cost  of  the  enterprise,  such  enterprise  will  ordinarily 
not  be  financed.  If  rates  are  made  sufficiently  high  in  the 
early  history  of  the  average  utility  to  provide  in  addition  to 
operating  expenses  and  dividends,  an  amount  sufficient  to  amor- 
tize the  cost  of  creating  the  business,  then  the  rates  will  usually 
be  so  high  as  to  reduce  business  to  such  a  point  as  to  jeopardize 
the  success  of  the  entire  enterprise.  The  history  and  records 
of  utility  corporations  show  that  it  is  utterly  futile  to  expect  that 
"the  rate-paying  public  can  well  afford  to  bear  the  temporary 
extra  cost  of  amortizing  all  intangible  and  questionable  elements 
of  capital  cost."  There  is  no  reason  why  the  future,  as  well  as 
the  present  users  should  not  pay  a  return  on  the  capital  properly 
expended  in  creating  the  business  the  same  as  they  are  expected 
to  do  on  the  capital  invested  in  the  establishment  of  the  physical 
property.  If  regulating  bodies  desire  to  have  the  cost  of  estab- 
lishing the  business  amortized,  and  will  make  the  futvn-e  rates 
sufficiently  high  to  cover  this  amortization,  as  well  as  pay  operat- 
ing cxix'nses  and  dividends  the  owners  cannot  object  to  such 
procedure,  but  because  the  owners  have  not  amortized  such  costs 
in  the  past  is  no  reason  for  arbitrarily  reducing  capital  investment 
by  such  sum.  If  the  capital  necessary  to  expend  in  building  up 
the  business  and  revenue  were  customarily  provided  by  the  sale 
of  securities,  rather  than  by  inclusion  in  operating  expenses, 
probably  regulating  bodies  would  not  fall  into  the  error  of  con- 
cluding that  the  money  sacrificed  by  the  investor  in  the  form  of 
dividends  docs  not  belong  to  him,  any  more  than  they  would  if 
he  had  invested  a  like  amount  as  original  capital.  It  has  been 
held  Ijy  some  few  authorities,  notably  the  Public  Service  Com- 


GOING  VALUE  233 

mission,  First  District  of  New  York,  that  "going  value"  has  been 
included  and  allowed  for,  when  instead  of  capitalizing  early- 
losses  incurred  in  establishing  a  revenue  there  is  allowed  a  "some- 
what higher  rate  of  return  in  later  years."  As  will  be  recog- 
nized, this  is  a  very  crude  way  of  approximating  justice.  A 
"somewhat  higher  rate  in  later  years"  is  very  indefinite  and 
may,  or  may  not,  cover  the  early  losses,  the  existence  of  which 
in  connection  with  developing,  or  attaching  the  business  to 
the  physical  property  is  generally  undisputed.  That  this 
theory  is  wrong  in  principle  is  recognized  by  a  large  number 
of  courts  and  commissions,  notably  the  Wisconsin  Commission, 
which  has  always  ruled  contrary  to  any  such  theory,  and, 
as  shown  above,  the  Court  of  Appeals  of  the  State  of  New 
York,  affirming  the  rulings  of  the  lower  court,  expressly  dis- 
approved any  such  theory  of  going  value  and  recognized  that 
going  value  should  be  included  as  a  separate  part  of  the  capital 
investment.  Such  procedure  permits  a  more  equitable  charge 
for  service  during  the  early  days  when  revenue  is  likely  to  be  small 
and  charges  for  service  relatively  high. 

"To  view  the  matter  in  another  aspect,  take  the  case  of  a  public 
service  corporation  with  a  plant  constructed  just  ready  to  serv-e  the 
pubUc,  It  is  going  to  take  time  and  cost  money  to  develop  the  highest 
efficiency  of  the  plant  and  to  establish  the  business.  Three  courses 
seem  to  be  open  with  respect  to  rate-making,  viz.:  1,  to  charge  rates 
from  the  start  sufficient  to  make  a  fair  return  to  the  investor  and  to 
pay  the  development  expenses  from  earnings,  a  course  likely  to  result  in 
prohibitive  rates  except  under  rare  and  favorable  circumstances;  2, 
to  treat  the  development  expenses  as  a  loss  to  be  recouped  out  of  earn- 
ings, but  to  be  spread  over  a  number  of  years,  in  other  words,  as  a 
debt  to  be  amortized,  that  involves  complications,  but  would  seem  to 
be  fairer  to  the  public  and  certainly  more  practical  than  the  first;  3, 
to  treat  the  development  expenses,  whether  paid  from  earnings  or  not, 
as  a  part  of  the  capital  account  for  the  purpose  of  fixing  the  charge 
to  the  public.  The  last  course  would  seem  to  be  fairest  to  both  the 
public  and  the  company,  as  well  as  the  most  practical."^ 

As  is  usual  in  the  ordinary  and  normal  course  of  business,  if  a 
utility  property  is  not  a  paying  one  at  the  start,  the  investors  are 
to  that  extent  deprived  of  that  to  which  they  are  equitably 

1  Court  of  Appeals,  State  of  New  York,  in  the  people  ex  rel..  Kings  County  Lighting 
Company  vs.  Wilcox  it  al.,  composing  Public  Service  Commission,  First  District,  Mar.  24, 
1914,  210  N.Y. 470. 


234  VALUE  FOR  RATE-MAKING 

entitled,  and,  hence,  are  involuntarily  compelled  to  reinvest  the 
amount  of  such  deficiency.  To  hold  that  investors  are  not 
entitled  to  interest  upon  this  portion  of  their  added,  but  more  or 
less  involuntary  investment,  is  equivalent  to  saying  that  they 
may  be  deprived  of  a  portion  of  their  investment  without  due 
compensation. 


('itapt1':k  IX 

DEPRECIATION 

General  Discussion. — Any  utility  that  has  onco  gotten  fairly 
started  must  include  in  its  operating  expenses  certain  items  to 
cover  the  cost  of  renewing  the  exhausted  physical  parts.  Where 
the  cost  of  the  individual  parts  renewed  is  a  relatively  insig- 
nificant part  of  the  total  operating  expenses  and  where  the  life 
of  tluise  exhausted  parts  is  relatively  brief — for  a  few  weeks,  a  few 
months  or,  at  most,  a  year  or  two — the  expenditures  are  included 
as  a  part  of  operating  expenses  under  the  head  of  "wear  and 
tear"  or  "maintenance"  without  controversy.  In  the  matter 
of  such  items  th(!re  is  seldom,  if  ever,  any  discussion  or  contro- 
versy with  regard  to  ignoring  their  cost  or  value  in  ascertaining 
the  present  fair  value  of  existing  property,  no  deduction  from 
cost  new  usually  being  made  for  "wear  and  tear." 

On  the  other  hand,  as  to  those  elements  of  property  that  cost 
relatively  large  amounts,  or  last  a  number  of  years,  there  is  wide 
divergence  of  opinion  as  to  the  proper  method  of  handling  the 
costs  and  providing  for  the  expenditures  necessary  when  renewing 
the  elements,  and  equal  difference  of  opinion  as  to  whether  or  not 
theestimated,  accruing  amount  of  tlepreciation  should  be  deducted 
from  cost  new  in  ascertaining  present  value.  It  will  be  seen  that 
the  reason  for  the  difference  in  opinion  as  to  this  matter  of  accru- 
ing reduction  in  remaining  usefulness  of  physical  property  de- 
pends primarily  upon  the  arbitrary  division  of  tinu;  adopted  for 
convenient  accounting.  If  public  utilities,  instead  of  making 
annual  reports,  were  accustomed  to  make  reports  only  once  in 
25  years,  the  so-called  depreciation  question  would  probably 
never  have  arisen,  as  affecting  the  basis  of  rate-making,  because 
most  or  all  charges  on  account  of  renewals  and  rejilacemtMits  (the 
life  of  so  many  physical  elements  having  a  life  of  less  than  25 
years)  would  then  become  merely  maintenance  and,  like  the 
other  items  of  wear  and  tear,  be  taken  care  of  in  the  gross  oper- 
ating expenses  for  the  25-year  period. 

235 


230  VALUE  FOR  RATE-MAKING 

"So  we  see  the  capital  expenditures,  as  distinguished  from  expenses, 
are  at  last  an  arbitrary  conception.  It  begins  with  the  idea  that  certain 
expenditures  have  an  efficiency  which  reaches  over  manj'  earning  periods 
extending  indefinitely  into  the  future.  But  nothing  physical  would 
last  so  long,  and  its  earning  power  might  even  have  less  permanence. 
To  meet  this  condition  we  arbitrarily  designate  certain  expenditures 
whose  affect  indefinitely  outlasts  the  immediate  earning  period  as 
'capital,'  and  then  in  the  same  arbitrary  way,  through  all  subsetjuent 
vicissitudes,  we  hold  them  to  their  first  value  by  maintenance,  renewal 
and  depreciation  charges,  which  are  borne  by  other  expenses. "^ 

If  this  fundamental  fact  were  generally  appreciated,  that  the 
division  of  time  in  the  life  of  utility  property  is  divided  into 
monthly  and  yearly  periods  for  purposes  of  accounting  conven- 
ience, it  would  be  easily  realized  that  charges  for  depreciation 
are  merely  provision  for  accruing  maintenance.  These  expendi- 
tures must  be  deferred,  because  neither  good  business  nor  effi- 
ciency permit  such  expenditures  for  accruing  wear  and  tear  until 
such  time  in  the  future  as  renewals  are  required. 

Considering  a  utility  having  many  physical  elements,  which  is 
neither  extending  nor  contracting  its  property,  in  a  town  in  which 
real  estate  values  are  at  a  standstill,  the  depreciated  value  of 
such  property,  neglecting  scrap  values,  is  approximately  50  per 
cent,  of  its  cost  new.  The  reason  so  many  appraisals  that  take 
into  account  accruing  depreciation  result  in  a  value  as  high  as 
ordinarily  found,  from  75  per  cent,  to  85  per  cent,  of  cost  new, 
is  due  primarily  to  the  fact  that  in  America  practically  all  utili- 
ties are  constantly  adding  and  enlarging  their  physical  plant,  so 
that  the  property,  as  a  whole,  is  not  in  a  normally  depreciated 
condition.  Where  extensions  and  additions  to  original  property 
are  not  being  made,  there  will  be  found  items  of  physical  plant 
and  ec}uipment  in  all  stages  of  life  from  new  to  that  just  ready 
to  be  discarded;  consequently,  every  plant  which  consists  of  a 
large  number  of  units  and  has  been  operated  for  sufficient  length 
of  time  to  have  every  element  replaced  one  or  more  times,  will  be 
found  approximately  in  a  50  per  cent,  theoretical  depreciated 
condition,  that  is,  on  the  average  the  property  will  be  half  worn 
out,  although,  if  properly  maintained,  as  useful  as  if  new  and 
rendering  100  per  cent,  service  value.  The  statement  of  this 
general  principle  was  first  published  by  the  writer  in  a  paper  on 
"Depreciation"  read  before  the  American  Institute  of  Electrical 

'  Handbook  of  Jiuilroud  Kxpcnsos,  J.  S.  Eaton,  pjige  .'J. 


DEPRECIATION  237 

Engineers  in  June,  1911.  It  has  also  been  more  fully  explained 
by  him  elsewhere/,  and  elaborated  by  Mr.  Jas.  E.  Allison 
and  others. 

Therefore,  if  accruing  depreciation  is  taken  into  account  in 
fixmg  the  basis  of  rates,  the  present  depreciated  value  of  almost 
any  large  property,  that  is  not  expanding  or  contracting,  and  in 
which  the  value  of  real  estate  is  but  a  small  percentage  of  the 
whole,  can  be  obtained  by  simply  cutting  the  cost  of  reproduction 
new  in  half  and  adding  5  to  10  per  cent,  to  cover  scrap  or  salvage 
value. 

Take,  for  example,  a  large  steam  railway  system.  It  would 
probably  be  admitted  without  very  much  argument  that  the  ties 
are  in  all  conditions  between  the  new  ones  that  may  have  been 
installed  yesterday  and  the  worn  out  ones  which  are  to  be  taken 
out  to-morrow,  so  that,  as  their  scrap  value  is  zero,  their  present 
theoretical  depreciated  condition  must  be  50  per  cent,  of  their 
total  cost  new.  It  would  probably  be  admitted,  without  argu- 
.ment,  that  the  same  applies  to  the  rails,  spikes,  probably  also  to 
each  of  the  various  classes  of  rolling  stock,  coal  cars,  freight  cars 
and  passenger  cars,  as  well  as  locomotives,  if  the  system  considered 
is  sufficiently  large.  The  only  exception  to  this  general  rule  of 
ascertaining  present  theoretical  depreciated  condition  is  when 
the  elements  considered  are  few  in  number  or  relatively  expen- 
sive. For  example,  a  highway  company  operating  a  large 
bridge  over  a  river  could  not  apply  the  so-called  Fifty  Per  Cent. 
Rule,  because  the  system  of  averages  does  not  control.  In  the 
same  way,  an  electric  light  company  could  not  apply  the  Fifty 
Per  Cent.  Rule  generally  to  all  its  property,  where  there  was  but  a 
single  generating  station  containing  few  large  units,  although  it 
might  apply  such  method  to  ascertaining  the  theoretical  de- 
preciated value  of  its  poles,  insulators,  wires,  meters  or  trans- 
formers going  to  make  up  its  distributing  system. 

In  the  preceding  discussion,  the  term  "depreciation"  has  been 
used  more  particularly  in  reference  to  exhaustion  of  physical 
property  by  reason  of  gradual  wearing  out.  In  case  of  inventions 
or  sudden  developments  in  the  art  that  immediately  render 
existing  apparatus  obsolete,  or  when  by  reason  of  exceedingly 
rapid  growth  of  business  installed  equipment  becomes  inadequate, 
relatively  large  amounts  of  property  may  be  almost  instantly 
depreciated,  and  in  such  cases  the  average  depreciated  condition 

i"The  Valuation  of  Public  Utility  Properties,"  by  Henry  Floy. 


238  VALUE  FOR  RA  TE-MA KING 

of  the  property,  as  a  whole,  might  be  well  under  50  per  cent.  On 
the  other  hand,  the  average  general  condition  might  be  ap- 
preciably above  50  per  cent,  in  the  case  of  utilities  owning 
relatively  large  amounts  of  phj-sical  property  that  does  not  de- 
preciate or  depreciates  very  slowly;  for  example,  a  water  power 
property  where  a  large  percentage  of  the  total  investment  is  in 
real  estate,  dams,  canals,  or  similar  structures.  From  the  fore- 
going it  will  be  seen  that  there  can  be  no  question  but  that  the 
market  value  of  utility  property  parts,  considered  for  purposes  of 
sale  without  an  inclusion  of  reserve  or  depreciation  funds  that 
may  have  been  accumulated,  is  very  much  less  than  the  cost  new, 
even  from  the  very  instant  installation  is  complete,  and  before 
the  new  property  has  been  put  into  service.  There  can  be 
no  argument  on  this  point,  and  it  is  freely  admitted  by  all  com- 
petent authorities  in  valuation  matters  that  value  for  the  pur- 
pose of  sale  and  value  for  the  purpose  of  rate-making  are  two 
entirely  different  matters.  That  value  for  rate-making  is  not 
market  value  may  be  illustrated  by  the  fact  that  cast-iron  pipe 
laid  in  the  streets  for  water  mains  may  cost  a  dollar  per  running 
foot  when  in  place,  but  as  soon  as  placed,  that  same  pipe  is  not 
worth,  aside  from  the  purpose  and  use  for  which  it  was  installed, 
more  than  a  small  fraction,  perhaps  10  or  20  cts.,  of  its  original 
cost.  It  would  hardly  be  argued,  by  the  most  ardent  enthusiasts 
of  market  value  as  a  basis  of  rate-making,  that  in  the  illustration 
used,  new  pipe,  just  installed,  is  only  entitled  to  a  return  on  its 
market  value.  It  is  generally  recognized  that  many  parts  of 
every  utility  are  incapable  of  being  detached  and  sold  separately, 
except  on  a  basis  of  scrap  value.  Thus  it  will  be  seen  that 
theoretical  depreciation,  or  market  value,  has  little  or  nothing  to 
do  with  the  value  upon  which  rates  should  be  based.  The  pur- 
pose of  a  depreciation  account  is  to  insure  the  continued  and 
serviceable  life  of  the  physical  plant  as  a  whole;  it  is  for  the  pur- 
pose of  providing  against  possible  depreciation  of  the  owner's 
investment. 

To  fix  rates  upon  depreciated  value  deters  the  making  of 
improvements,  except  for  exhaustion  of  physical  property.  The 
replacing  of  existing  property  before  it  is  worn  out,  on  the 
grounds  of  obsolescence  or  inadequacy,  would  accord  only  scrap 
value  to  the  discarded  property,  thereby  losing  to  the  owners  the 
difference  in  value  between  scrap  and  the  unaccrued  depreciated 
value.     On  the  other  hand,  if  cost  new  is  taken  as  a  basis  of  re- 


DEPRECIATION  239 

turn  allowed,  the  owner,  being  permitted  to  replace  a  depreciated 
by  a  new  unit  without  aiTecting  his  capital  account  (where  the 
cost  of  the  old  and  the  new  unit  is  the  same),  will  gladly  and 
promptly  take  advantage  of  any  improvements  in  the  art  or 
demands  for  greater  capacity,  in  order  to  keep  his  plant  thor- 
oughly up  to  date.  The  use  of  depreciated  values  for  rate-making 
discourages  invention  or  the  substitution  of  improved  or  new  prop- 
erty for  the  existing  plant.  This  is  too  frequently  illustrated 
by  the  endeavor  of  public  utility  corporations  to  keep  what  is 
really  superseded  property  or  plant  on  its  books  and  in  use  as 
reserve  equipment,  in  order  that  its  value  may  be  included  in  the 
appraisals  that  are,  or  have  been,  made  by  public  regulating 
bodies. 

"Absolute"  and  "Theoretical"  Depreciation. — Before  under- 
taking to  discuss  proper  methods  of  estimating  and  allowing  for 
depreciation,  it  is  essential  to  have  clearly  in  mind  just  how 
depreciation  actually  takes  place  and  in  what  way  it  effects 
physical  property. 

Where  property  is  no  longer  of  service,  it  must  be  depreciated 
down  to  the  value  at  which  it  may  be  sold,  even  though  that 
value  is  as  low  as  scrap  value.  On  the  other  hand,  apparatus 
that  is  in  use  and  rendering  a  service  economically,  may  for  the 
purpose  for  which  it  was  intended,  be  as  valuable  as  when 
originally  installed,  although  its  age  may  be  approaching  the 
limit  of  its  life.  Take  for  example  a  steam  engine  which  though 
having  been  in  use  for  the  greater  part  of  its  estimated  life  is, 
through  proper  maintenance,  in  as  good  condition  to  render 
service  as  at  any  time  in  its  history.  If  its  annual  maintenance 
charge  is  no  greater  than  in  the  earlier  years  of  its  history,  its 
"service  value"  to  the  company  as  a  going  piece  of  property  is  as 
great  as  when  first  installed. 

What  then  do  we  mean  by  depreciation?  Reference  to  Fig.  1 
indicates  graphically  several  ways  in  which  depreciation  actually 
takes  place,  as  well  as  usual  methods  heretofore  adopted  in  con- 
sidering and  evaluating  depreciation. 

Assume  that  a  given  piece  of  physical  property  has  an  esti- 
mated life  of  twenty  years,  represented  by  the  abscissa  OB,  and 
that  it  has  a  given  value  in  dollars,  shown  by  the  length  of 
the  ordinate  OA.  Let  the  ordinate  OC  represent  the  worth  in 
dollars  of  the  apparatus  as  scrap  or  junk,  then  the  abscissa  CD 
will   represent  the  scrap  value   throughout  the  life.     This  line 


240 


VALUE  FOR  RATE-MAKING 


is  usually  approximately  a  straight  line,  deviating  therefrom 
simply  by  fluctuations  in  the  value  of  scrap  material,  which  is 
usually  within  fairly  narrow  limits.  The  point  D  is  the  value 
of  the  apparatus  in  question  at  the  end  of  its  life.  It  may  reach 
this  value  through  any  one  of  several  methods  of  depreciation, 
shown  graphically  by  the  curves  No.  1,  2,  3,  4,  5  and  6. 

Curves  1,  2  and  6  may  be  said  generally  to  represent  "absolute 
depreciation;"  and  curves  3,  4,  5  "theoretical  depreciation." 


Considering  "absolute  depreciation,"  curves  1  and  2  represent 
the  values,  during  any  period  of  their  lives,  of  most  pieces  of 
physical  property,  determined  from  tlie  standpoint  of  bargain 
and  sale  for  use  elsewhere.  The  salable  value- of  new  apparatus 
depreciates  very  rapidly  from  the  moment  installed  and  then 
gradually  during  the  remainder  of  its  Hfe  down  to  "scrap  value." 
The  values  thus  illustrated  arc  iiidependcnit  of  the  service  for  the 
particular  installation  for  which  the  apparatus  has  been  pur- 
chased and  installed.  Curve  1  may  fairly  represent  the  worth 
of  certain  pieces  of  property  such  as: 


DEPRECIATION  241 

(a)  Special  machinery,  the  vahic  of  which,  for  use  in  connection 
other  than  that  for  which  it  has  ham  installed,  would  necessitate 
such  a  large  expenditure  for  modification  of  design  to  make  it 
useful  elsewhere  that  little  more  than  scrap  value  can  be  obtained 
from  same. 

(6)  Property  the  cost  of  removing  which,  compared  to  its  cost 
new,  is  relatively  high;  for  example,  ties  for  track,  or  wootlen 
poles  of  a  transmission  line. 

Curve  2  represents  sales  value  for  more  easily  transported 
property,  as  for  example  the  rolling  stock  or  synchronous  con- 
verters of  a  street  railway  system  or  transformers  and  meters  of 
a  lighting  company. 

The  classes  of  depreciation  indicated  by  the  curves  1  and  2 
might  properly  be  called  salvage  values  and  approximate  scrap 
or  junk  values,  the  principal  difference  being  the  propertj^  is  sold 
for  what  it  is  worth  as  a  unit  rather  than  for  its  dismembered 
elements.  It  will  be  evident  at  once  that  depreciation  of  these 
classes  cannot  fairly  be  used  in  determining  the  value,  on  the 
basis  of  barter  and  sale  in  the  general  market,  of  the  physical 
property  of  an  operating  entity.  That  this  is  true  and  the  view 
taken  by  the  courts  will  be  evident  from  consideration  of  the 
decisions  in  the  Consolidated  Gas  and  other  similar  cases  and 
even  in  the  Knoxville  Water  case,  which  is  generally  considered 
the  most  radical  decision  in  the  way  of  depreciating  physical 
value. 

Curve  6  indicates  depreciation  due  only  to  wear  and  tear  until 
just  before  the  close  of  life,  at  which  time  other  classes  of  deterio- 
ration may  appear.  The  curve  is  based  on  the  assumption  that 
the  apparatus  in  question  will  be  used  for  the  purpose  for  which 
it  was  installed,  throughout  its  life,  and  being  maintained 
in  good  operating  efficiency,  100  per  cent.,  is  just  as  good  for  the 
purpose  of  use  as  the  day  it  was  installed,  aside  from  such  slight 
deterioration  as  results  from  wear  and  tear.  That  is,  the  value 
of  the  apparatus  or  construction,  being  used  for  its  original 
purpose,  is  equal  to  its  cost,  new  or  original,  less  the  evaluation 
of  the  wear  which  has  taken  place;  for  example,  a  few  tubes  in  a 
boiler  might  be  so  badly  burned  as  to  render  the  boiler  unfit  for 
service.  The  value  of  the  boiler  as  a  whole  in  its  assumed  condi- 
tion is  practically  worth  little  more  than  scrap,  but  by  the 
expenditure  of  a  few  dollars  in  renewing  the  burned-out  tubes 
the  value  of  the  unit,  say  for  the  purpose  of  original  installation 


242  VALUE  FOR  RATE-MAKING 

and  use,  Is  equal  to  the  value  of  a  new  boiler.  In  any  large 
system  there  is  constantly  a  large  number  of  parts  always 
approaching  the  time  of  renewal.  At  any  given  instant  of 
appraisal  some  such  parts  will  be  found  completely  worn  out  and 
the  value  of  their  replacement  must  be  deductetl  from  the  cost 
new  in  order  to  obtain  the  real,  actual  ami  "absolute"  deprecia- 
tion at  the  instant  of  appraisal.  But  assuming  the  property  as 
a  whole  is  kept  in  first-class  operating  condition,  that  there  is  no 
inadequacy,  obsolescence,  or  deferred  maintenance  and  ignoring 
such  slight  deterioration  as  results  from  wear  and  tear  at  any 
given  instant  which  maybe  apparent  in  detail  parts  in  the  sj^stem, 
the  depreciation  effecting  the  value  of  the  plant  for  the  purpose 
installed  may  be  considered  nil  practically  throughout  its  life,  as 
an  operating  property.  In  a  given  unit  just  before  the  close  of 
life  other  classes  of  depreciation  than  wear  and  tear  may  set  in  or 
deferred  maintenance  may  be  allowed  to  appear,  in  which  case, 
of  course,  depreciation  must  be  considered,  but  otherwise  the 
value  of  the  property  for  its  original  use  is  equal  to  the  cost  to 
reproduce  new,  and  it  is  the  real  value  of  its  physical  property  to  a 
"going  concern."  This  value  or  its  equivalent  is  that  generally 
allowed  in  "purchase  and  sale  transactions,"  and  has  been  recog- 
nized by  pul)lic  service  commissions  and  legal  authorities. 

"If  the  present  value  exclusively  were  to  be  taken  as  the  basis, 
respondent  would  not  receive  credit  for  having  installed  any  part  of  its 
plant  at  full  cost.  The  present  value,  as  of  June  30,  190S,  must, 
therefore,  be  increased  by  the  amount  of  the  estimated  depreciation  on 
that  part  of  the  plant  which  the  company  installed  new."^ 

"Of  the  physical  plant  alone,  the  most  equitable  valuation  for  rate- 
making  purposes  appears  to  be  best  represented  by  the  original  cost  of 
the  plant  and  by  the  cost  of  reproducing  it."^ 

This  "service  value"  would  also  seem  to  be  recognized  by  the 
courts  botii  in  rate  cases  and  in  determining  valuations  for  sale.* 

"Probably  a  fair  statement  would  be  that  the  physical  value  of  the 
plant  is  its  value  as  a  performing  plant  for  the  purposes  for  which  it  was 
designed."* 

'  F.  B.  L.  Fuller  vs.  Wausau  Street  Railroad  Co.,  Railroad  Commission,  of  Wisconsin, 
April  1,  1910. 

*G.  W.  Hill  el  at.  vs.  Antigo  Water  Company,  Railrmid  Commission  of  Wisconsin, 
August  .3,  1909. 

^City  of  Omaha  vs.  Omaha  Water  Co.  1  1«  T.  S.,  202.  Wilcox  vs.  Consolidated  Gas 
C<i.,  212  U.  S..  19. 

*  Columbus  Railway  &  Light  Co.  vs.  City  cjf  C^olumljus,  Circuit  Court  U.  S.  Southern 
District  of  Ohio,  report  of  .Muster,  page  34. 


DEPRECIATION  243 

If  any  contrary  position  were  assumed,  namely,  that  only 
"sales  value,"  indicated  under  most  favorable  circumstances 
by  curves  1  and  2,  were  to  be  used  in  determining  present  value, 
then  a  large  portion  of  every  going  property  would  be  practically 
valueless  the  day  after  construction  and  installation  was  com- 
pleted, because  the  expense  of  removal  would  amount  to  more 
than  the  cost  of  new  in  the  open  market:  for  example,  ties  in  a 
railway  property;  foundations  and  settings  for  machinery;  pipe, 
deeply  buried;  cross-arms  and  many  wooden  poles. 

Property — except  real  estate  on  road  bed — cannot  usually  be 
maintained  at  100  per  cent,  of  its  original  value;  ultimate  econ- 
omy seeks  only  100  per  cent,  operating  efficiency. 

In  contradistinction  to  determination  of  present  value  by  the 
use  of  depreciation  expressed  in  the  curves  1,  2  and  6,  which  may 
be  termed  "absolute,"  the  curves  3,  4  and  5  indicate  several 
classes  of  "theoretical"  depreciation  which  have  been  quite 
widely  used  in  some  cases  for  estimating  present  values,  but 
more  often  for  determining  the  yearly  theoretical  deterioration 
for  purposes  of  establishing  depreciation  funds,  which,  however, 
is  quite  a  different  subject.  Making  a  theoretical  estimate  of 
the  probable,  future,  average,  annually  accruing  deterioration  of 
certain  property  to  provide  an  item  in  book-keeping  accounts  of 
operating  expense  has  nothing  whatever  to  do,  in  making  an 
appraisal,  with  fixing  the  definite  amount  of  absolute,  actual  or 
accrued  depreciation  which  depends  upon  the  present  condition 
of  physical  property,  determinable  from  inspection  and  not  upon 
historical  documents,  depreciation  funds,  or  disputed  theoretical 
conclusions.  Nevertheless,  the  erroneous  application  of  rates  of 
depreciation  in  the  attempt  to  determine  present  commercial 
values  for  purposes  of  capitalization  is  fairly  common. 

These  three  curves  3,  4  and  5  represent  classes  of  depreciation 
which  seldom,  if  ever,  occur  in  practice  but  are  convenient  for 
purposes  of  estimate,  particularly  curve  3,  which  represents 
what  is  called  "straight  line  depreciation."  As  indicated,  it 
assumes  a  gradual  and  constant  reduction  in  the  value  of  prop- 
erty throughout  its  life.  The  significance  is  that  if,  from  the 
cost  of  apparatus,  the  value  to  be  obtained  at  the  end  of  its  life, 
namely,  the  scrap  value,  is  deducted,  the  remainder  divided  by 
the  assumed  life,  in  years,  of  the  apparatus,  will  give  the  amount 
in  dollars  to  be  laid  aside  annually  to  accumulate  a  fund  sufficient 
to  replace  the  property  at  the  end  of  its  life  without  interest. 


244  VALUE  FOR  RATE-MAKING 

Curve  4  is  closely  related  to  curve  3;  the  annual  depreciation 
fund,  however,  being  less  because  it  is  assumed  that  the  uniform 
amount  of  money  laid  aside  annually  during  the  life  of  the  prop- 
erty will  be  put  out  at  interest  and  compounded  so  that  owing 
to  the  accumulation  of  interest  the  amounts  annually  laid  aside 
will  be  less  than  in  the  case  of  "straight  depreciation."  Curve 
4  is  called  the  "sinking  fund"  method. 

Curve  5,  a  modification  of  curve  4,  is  based  on  the  assumption 
that,  instead  of  laying  aside  a  regular  amount  annually  and  com- 
pounding, the  amount  laid  aside  will  be  small  at  first,  gradually 
increasing  in  amount  as  the  earning  power  of  a  property  in- 
creases, as  it  generally  does,  with  its  life.  These  amounts  are 
then  assumed  to  be  put  out  at  compound  interest  so  as  to  aggre- 
gate original  cost  of  the  apparatus  at  the  end  of  its  life.  No 
general  rule  has  been  developed  as  to  the  proper  amounts  to 
begin  laying  aside  or  in  what  proportion  they  shall  increase;  but 
it  is  clear  that  the  smaller  are  the  amounts  in  the  beginning  the 
larger  they  must  be  toward  the  end  of  the  life  of  the  apparatus. 

This  latter  plan  of  providing  depreciation  funds  has  the 
advantage  of  more  nearly  proportioning  the  annual  depreciation 
payments  in  accordance  with  revenue,  and  for  most  pieces  of 
property  will  more  closely  approximate  the  deterioration  actually 
taking  place. 

A  fourth  plan  of  determining  "theoretical"  depreciation  has 
been  used  to  limited  extent.  It  consists  in  assuming  a  given 
life  for  the  property  in  question,  ascertaining  the  annual  rate 
of  depreciation  and  then  applying  that  rate  uniformly  to  the 
principal  diminished  in  amount  each  year  by  the  deduction  for 
deterioration.  For  example,  if  the  principal  invested  were 
S2000  and  the  rate  assumed  is  10  per  cent.,  the  amount  charged 
off  for  depreciation  the  first  year  would  be  $200,  leaving  the 
principal,  $1800,  on  which  10  per  cent,  or  $180  would  be  charged 
off  the  second  year,  and  $1G2  the  third  year,  etc.;  thus  theamount 
charged  off  becomes  progressively  less  and  the  life  of  the  prop- 
erty becomes,  theoretically  at  least,  infinite.  Of  course  this 
method  can  be  modified  from  the- "straight  Hne"  depreciation 
illustration  used  above  to  the  "sinking  fund"  method,  if  desired. 

From  the  preceding  it  will  be  seen  that  any  one  of  these  four 
methods  of  estimating  depreciation  is  based  on  absolutely  arbi- 
trary assumptions.  Practically  there  is  no  more  logical  reason 
per  se  why  the  fund — if  necessary — to  replace  the  property  at 


DEPRECIATION  245 

the  end  of  its  life  should  be  provided  in  any  one  of  the  several 
methods  suggested  by  the  curves  rather  than  in  any  other  of  the 
several  methods.  Each  method  will  accomplish  the  same  result, 
but  it  will  be  seen  at  a  glance  that  in  applying  curves  3,  4  or  5, 
the  amounts  to  be  laid  aside  annually  will  vary  considerably,  and 
to  that  extent  effect  net  income;  similarly,  the  effect  on  the 
worth  of  the  owner's  investment  will  also  vary  with  the  curve 
used,  being  appreciably  less  for  "straight  line"  depreciation. 

Accruing  Depreciation  not  Allowed. — Whatever  weight  there 
may  be  in  the  argument  that  theoretical  depreciation  should  be 
deducted  from  cost  new  when  properties  are  being  considered 
which  have  originated  under  public  service  regulation,  such  argu- 
ments can  have  no  weight  with  reference  to  such  properties  that 
were  in  existence  before  the  present  regime  of  public  control  was 
instituted.  Not  only  were  the  owners  of  public  utilities  encour- 
aged to  consider  that  all  revenue  beyond  that  required  to  pay  for 
ordinary  operating  expenses  was  net  income  and  belonged  to  the 
owners,  but  the  courts  absolutely  prohibited  many  public  utility 
owners  from  laying  aside  annually  out  of  revenue,  and  accumu- 
lating in  funds,  amounts  considered  necessary  for  providing 
against  future  accrued  depreciation.  With  these  decisions  of 
the  courts  in  mind,  how  unfair  is  it  to  insist  that  those  utilities 
doing  business  long  before  the  present  form  of  public  utility  regu- 
lation began  should  have  the  value  of  their  property  determined 
and  their  rates  fixed  on  the  basis  of  deducting  theoretical  accru- 
ing depreciation  from  cost  new,  in  order  to  ascertain  so-called 
present  value,  at  least  in  amounts  larger  than  those  determined 
by  the  accumulation  in  reserve  funds  established  since  public 
service  regulation  was  instituted.  Not  only  have  the  State 
courts  in  widely  separated  parts  of  the  United  States  stated  that 
no  deduction  should  be  made  from  net  income  to  provide  against 
accruing  depreciation,  before  ascertaining  the  amount  that  might 
fairly  be  paid  out  as  dividends,  but  the  Supreme  Court  itself  has 
ruled  on  this  question  and  held  that  only  expenditures  actually 
made  can  be  claimed  as  proper  deductions  from  earnings. 

In  1890  the  authorities  of  the  City  of  San  Diego,  Cal.,  passed 
an  ordinance  reducing  and  fixing  the  rates  of  the  San  Diego 
Water  Company.  The  company  brought  an  action  in  the  Supe- 
rior Court  of  California  to  annul  the  ordinance  and  enjoin  its 
enforcement,  on  the  grounds  that  the  rates  fixed  were  insufficient 
to  provide  revenue  sufficient  to  cover  expenses  and  a  fair  return 


246  VALUE  FOR  RATE-MAKING 

upon  the  value  of  the  property.  The  Court  found  that  the  water 
plant  had  cost  S750,000  and  "  that  the  annual  depreciation  of 
the  plant  on  account  of  natural  decay  and  use  amounted  to  31^ 
per  cent,  of  its  value." 

Thus  it  will  be  seen  that  in  annual  operating  expenses  the 
Court  included  an  amount  to  cover  theoretical  accruing  depre- 
ciation. This  inclusion  of  an  allowance  for  depreciation,  the 
Superior  Court  found,  reduced  the  net  income  to  an  amount 
insufficient  to  afford  a  fair  return  on  the  value  of  the  property, 
and  in  consequence  the  Court  declared  the  ordinance  void. 
Upon  appeal  by  the  city  to  the  Appellate  Court  of  California 
from  the  decision  of  the  lower  Court,  above  referred  to,  the 
Appellate  Court  reversed  the  Superior  Court,  saying  on  page  574: 

"  With  regard  to  the  question  of  the  depreciation  of  the  plant  by  use, 
it  is  sufficient  to  say  that  ordinary  repairs  should  be  charged  to  current 
expenses,  that  substantial  reconstruction  or  replacement  should  be 
charged  to  the  construction  account,  and  that  depreciation  should  not 
otherwise  be  considered." 

Two  other  judges  who  sat  in  the  case  wrote  concurring  opin- 
ions; that  of  Judge  Garroutte,  on  page  582,  says: 

"This  balance  (after  making  deductions  for  operating  expenses 
and  interest)  of  $25,000  is  profit,  unless  it  is  swallowed  up  by  the  finding 
of  the  Court  that  the  plaintiff's  plant  suffered  an  annual  depreciation  of 
3H  per  cent.,  and  the  conclusion  of  law  therefrom  that  a  percentage 
upon  the  investment  to  that  amount  should  be  added  to  the  operating 
expenses  before  the  point  is  reached  where  profit  begins.  We  are  sat- 
isfied that  this  finding  has  no  support  in  the  evidence,  even  conceding 
the  conclusion  of  law  drawn  therefrom  sound.  In  the  first  place,  the 
evidence  develops  that  there  can  be  no  general  depreciation  of  this 
plant  as  a  whole.  There  are  tunnels,  wells,  reservoirs,  water  rights  and 
real  estate,  amounting  to  more  than  one-half  of  the  valuation  of  the 
plant,  there  is  no  depreciation  on  these  things;  there  is  no  wear  and  tear, 
no  permanent  and  gradual  destruction  by  use  and  age.  Most  of  them 
stand  as  everlasting  as  the  hills. 

"The  theory  of  the  plaintiff  in  this  regard  seems  to  be  that  the  life  of 
a  plant  of  this  character  may  be  approximated  at  30  years,  and  that  a 
sinking  fund  of  one-thirtieth  its  value  should  be  collected  from  the  rate 
payers  annually  and  laid  aside  to  be  handed  to  the  stockholders  upon 
the  sad  occasion  of  its  demise,  as  alleviating  salve  to  their  sorrow." 

Another  judge  writes  a  concurring  opinion,  which,  however, 
throws  no  particular  additional  light  on  the  subject  here  being 


DEPRECIA  TION  247 

discussed.  Out  of  the  six  judges  who  passed  on  the  matter,  only 
one,  Judge  Beatty,  wrote  a  dissenting  and  separate  opinion 
which  says,  on  page  588: 

"As  to  current  expenses,  all  operating  expenses  reasonably  and 
properly  incurred  should  be  allowed,  taxes  should  be  allowed,  and 
the  cost  of  current  repairs. 

"In  addition  to  this,  if  there  is  any  part  of  the  plant,  such  as  main 
pipes,  etc.,  which  at  the  end  of  a  term  of  years  (20  years,  for  instance) 
will  be  so  damaged  and  worn  out  to  require  restoration,  an  annual 
allowance  should  be  made  for  a  sinking  fund  sufficient  to  replace  such 
part  of  the  plant  when  it  is  worn  out."^ 

From  the  preceding,  it  is  clearly  evident  that  the  Court 
thoroughly  understood  the  question  upon  which  it  was  ruling, 
namely:  whether  or  not  an  annual  allowance  to  cover  estimated 
accruing  depreciation  of  physical  property,  which  must  ulti- 
mately be  replaced,  should  or  should  not  be  included  in  operating 
expenses.  Judge  Beatty  definitely  held  that  such  allowance 
should  be  included,  but  the  majority  of  the  Court  overruled  him 
and  held  that  no  such  allowance  should  be  granted  the  owners 
for  the  protection  of  their  property. 

In  a  later  decision,  the  Appellate  Court  of  California  reaffirmed 
its  position  with  regard  to  allowances  for  depreciation  where  the 
Redlands  Water  Company  brought  action  to  annul  a  city  ordi- 
nance upon  the  ground  that 

"the  rates  therein  prescribed  would  not  yield  a  revenue  sufficient  to 
enable  it  to  pay  the  interest  on  its  indebtedness,  its  operating  expenses 
and  taxes,  and  for  keeping  its  plant  in  repair  and  replacing  the  same."- 

The  matter  having  been  passed  on  by  the  lower,  so-called 
Superior  Court,  which  had  allowed  $2,898.60,  to  cover 

"the  annual  depreciation  of  the  plant,  aside  from  the  amount  requisite 
for  its  maintenance  and  repairs  during  the  year."^ 

the  Appellate  Court,  referring  to  its  previous  discussion  of  the 
principles  involved  and  its  ruling  in  the  preceding  San  Diego 
case,  again  reversed  the  Superior  Court's  ruling  and  refused  to 
recognize  the  depreciation  allowance  or  to  annul  the  ordinance. 
In  view  of  the  full  discussion  in  the  San  Diego  case,  including 
the  ruling  of  the  Superior  Court  and  the  reversal  of  the  holding 

>  San  Diego  Water  Co.  vs.  City  of  San  Diego,  118  Calif.  556. 

^  Redlands  Lugonia  &  Crafton  Domestic  Water  Co.  vs.  City  of  Redlands  et  al.  121  Cal. 
312. 


248  VALUE  FOR  RATE-MAKING 

of  this  Court  by  the  Appellate  Court  of  California,  and  the  re- 
affirmation of  the  principles  involved  in  the  Redlands  ease,  it  is 
interesting  to  compare  the  rulings  of  the  Railroad  Commission 
of  California,  which  holds  that  the  fair  present  value  of  utility- 
property  is  found  after  deducting  the  amount  of  estimated, 
accruing  depreciation,  which  the  Appellate  Court  has  previously 
ruled  the  owners  of  the  property  shall  not  be  allowed  to  provide 
out  of  revenue.     Comment  is  unnecessary. 

In  the  case  of  a  disagreement  between  stockholders  of  the  Flint 
and  Pierre  Marquette  Railroad  Company,  the  Federal  Court 
refused  to  include  in  operating  expenses  certain  charges  that  had 
been  made  to  cover  accruing  depreciation.  The  directors  of  the 
railroad  had  charged  to  operating  expenses  certain  items  of  new 
construction,  but  as  to  certain  steamboats  operating  on  Lake 
Michigan,  the  Court  says: 

"In  1884  there  was  a  charge  against  expenses  for  depreciation  on 
these  steamers  amounting  to  $6,000.  In  1885,  there  was  a  like  charge 
for  depreciation,  and  also  a  charge  of  $2,500,  as  depreciation  of  dining 
halls,  the  total  charges  making  $14,500.  These  sums  were  not  actually 
expended  out  of  earnings  but  were  estimated  and  charged  against  oper- 
ating expenses.  This  was  not  proper.  No  depreciation  account  was 
either  kept  or  warranted  by  the  charter,  as  between  the  two  classes  of 
stockholders,  and  no  expenditures  having  actually  been  made  to  meet 
such  depreciation,  the  estimated  amount  thereof  could  not  properly  be 
deducted  from  earnings  or  net  income.  The  sum  of  SG,000  should, 
therefore,  be  credited  back  to  earnings  for  1884,  and  $8,500  for  1885."' 

The  Supreme  Court  itself  concurred  in,  and  confirmed,  the 
holdings  of  the  lower  court  by  excluding  from  operating  expenses 
charges  for  accruing  and  unexpended  depreciation.  In  the  case 
of  the  Federal  Government  vs.  the  Kansas  Pacific  Railway  seek- 
ing to  determine  the  net  earnings  of  the  railroad,  the  Supreme 
Court  reversed  the  judgment  of  the  Circuit  Court,  from  which 
appeal  had  been  taken,  expressly  holding  with  regard  to  "de- 
preciation account  or  expenses  not  charged  up"  that: 

"This  is  explained  to  be  the  amount  necessary  to  put  the  road  in 
proper  repair,  but  which  was  not  actually  expended  for  that  purpose. 
We  are  clearly  of  the  opinion  that  it  is  not  a  fair  charge.  Only  such 
expenditures  as  are  actually  made  can,  with  any  propriet}',  be  claimed 
as  a  deduction  from  earnings."^ 

•  Macintosh  el  al.  vs.  Flint  &  Pierre  Marq.  R.  R.  el  al.  34  Fed.  Rep.  609. 

*  U.  S.  vs.  Kansas  Pac.  Ry.  Co.,  99  U.  S.  459.  See  also:  Tutt  vs.  Land.,  50  Geo.  339,  and 
Emery  vb.  Wilson,  79  N.  Y.  78. 


DEPRECIATION  249 

Depreciation  Estimates  Inaccurate. — There  is  no  way  of  abso- 
lutely and  accurately  measuring  the  amount  of  accruing,  theoreti- 
cal depreciation  existing  in  physical  property  at  any  given  time. 
All  estimates  of  theoretical  depreciation  are  based  on  assumptions 
as  to  the  probable  life,  which  is  fixed  from  a  consideration  of  the 
law  of  variation  of  the  periods  of  expiring  usefulness  of  the 
different  elements  of  property.  It  is  only  when  a  particular 
unit  has  been  abandoned,  or  replaced,  that  fact  replaces  judg- 
ment and  estimate,  consequently,  the  accurate  amount  of  accru- 
ing depreciation,  which  exists  in  any  individual  element  at  a  given 
time,  is  indeterminate.  Theoretical  depreciation  can  be  assumed 
to  apply  only  to  sufficiently  large  groups  of  units  of  the  same  type 
and  character,  so  that  the  law  of  chances,  or  the  average  law 
of  contingencies  will  apply.  Consequently,  the  futility  of 
attempting  to  determine  the  theoretical  depreciation  of  a  single 
unit,  differing  from  all  others  as  to  size,  or  type,  owned  by  the 
same  utility,  is  at  once  apparent.  The  application  of  an  average 
life,  determined  from  the  consideration  of  the  shortest  life,  and  the 
longest  life  with  all  intermediate  lives  of  similar  pieces  of  appara- 
tus in  various  localities,  and  existing  under  widely  different  condi- 
tions of  service,  may  or  may  not  be  applicable  to  the  particular 
case  being  considered.  Thus,  it  will  be  recognized  that  the  at- 
tempt to  fix  the  value  of  any  particular  piece  of  property,  render- 
ing a  given  service  by  the  application  of  general  law,  based  upon 
average  results  obtained  vmder  widely  varying  conditions,  may  do 
great  injustice,  either  by  giving  too  high  a  value  to  the  particular 
element  being  considered — if  it  has  been  mistreated,  and  allowed 
to  get  out  of  repair — or  too  low  a  value,  if  through  high  degree  of 
maintenance  and  little  use,  it  is  worth  more  than  the  average. 

It  is  a  fact,  becoming  to  be  generally  recognized,  that  physi- 
cal property  does  not  deteriorate  in  accordance  with  the  straight 
line  method  of  estimating  depreciation;  it  more  nearly  approxi- 
mates the  sinking  fund  method,  but  in  most  instances  that 
method  would  have  to  be  considerably  modified  to  represent  the 
true  rate  of  depreciation.  ''The  use  of  averages  is  misleading 
and  cannot  be  expected  to  yield  results  in  line  with  a  careful 
study  of  the  facts."  Adaptability  of  the  unit  to  the  entire  equip- 
ment, conditions  of  use,  care  in  maintenance  and  climatic  con- 
ditions, are  all  local  factors,  which  mean  variations  from  the 
average. 

That  neither  the  straight  line,  nor  the  sinking  fund  method, 


250 


VALUE  FOR  RATE-MAKING 


nor  estimating  the  condition  at  any  given  period,  in  even  a  large 
number  of  units,  accurately  discloses  the  real  depreciated  condi- 
tion is  shown  by  the  following  explanation  and  illustrations  of 
actual  depreciation  rates  given  by  Mr.  Edwin  Gruhl. 

"As  modified  by  the  addition  of  a  minimum  service  value,  the  de- 
preciation rates  upon  a  sinking  fund  and  straight  line  basis  may  be 
graphically  illustrated  in  Fig.  2.  An  average  life  has  been  assumed  of 
40  years.     At  20  years,  or  half  the  average  life,  the  present  value  will 


100 

95 

90 

85 

•80 

75 

70 

I  65 

S60 

**  55 
o 

•3  50 
> 
I  45 

I  40 

I  35 

I  30 

25 

20 

15 

10 

5 

0 


r- 

~ 

s, 

s 

Depreciation  Rate 

Straight  Line  and 

Sinking  Fund  i% 

Theories  with  Average 

Life  of  40  Years 

\ 

s 

> 

\ 

V 

\ 

\ 

\ 

V 

V 

\ 

s 

V 

\ 

\ 

\ 

i 

V 

\ 

> 

> 

V 

V 

\ 

\ 

k 

V 

\ 

\ 

> 

> 

V 

[ 

\ 

\ 

\ 

1 

\ 

V 

\ 

\ 

1 

\ 

\ 

- 

\ 

\ 

V 

1 

y 

il 

le 

\ 

1 

Mini 

mui 

' 

\ 

\ 

^ 

\ 

. 

30  40  50 

Years  in  Service 

Fig.  2. 


60 


70 


80 


aggregate  50  per  cent,  upon  a  straight  line  basis  and  68.7  per  cent, 
upon  a  4  per  cent,  sinking  fund  curve  basis.  Upon  a  3  per  cent,  curve 
the  percentage  at  the  same  age  would  have  aggregated  64  per  cent., 
and  upon  a  2  per  cent,  curve  it  would  have  aggregated  60  per  cent. 

"The.se  curves  may  be  viewed  in  two  ways.  They  may  be  supposed  to 
represent  either  the  gradual  deterioration  in  value  of  an  average  unit 
of  e(|uipment  or  the  law  of  deterioration  of  a  large  numlx;r  of  units  of 
an}'  life.  If  we  deal  with  the  average,  we  suppose  upon  the  straight 
line  basis  that  50  per  cent,  of  its  life  and  usefulness  has  passed  away  at 
say  20  years,  or  one-half  the  average  life,  but  that  if  the  average 
unit  shall   survive   the   average   life  oi-    10  years  it  will  continue  at  a 


DEPRECIATION 


251 


minimum  service  percentage  irrespective  of  the  probability  that  its 
additional  expected  life  or  usefulness  is  small  or  large.  If  we  deal  with 
the  group,  however,  we  assume  that  at  20  years  only  50  per  cent,  of  the 
group  is  expected  to  survive,  and  that  at  the  average  age,  the  survivors 
will  have  an  indefinite  expectancy  of  life. 

"The  only  method  of  testing  these  assumptions  is  to  apply  our  actual 
experience  to  these  assumed  rules.  When  observations  as  to  the  timing 
of  replacements  from  any  cause  are  summarized  in  accordance  with  the 

100- 
95 
90 
85 
80 
75 
70 

<B 

I  65 

0) 

M60 

o, 
S55 

? 

Sso 

o 

m45 

§40 
o 

I  35 


— 

'^ 

^ 

Depreciaton 

Kate 

Water  Works  Pump 

Alvord 

48  Pumps 

- 

s, 

^ 

s 

\ 

^ 

\ 

\ 

' 

V 

\ 

^ 

\ 

1 

\ 

\ 

s 

\ 

V 

J 

^ 

s 

y 

\ 

\ 

L 

\ 

\ 

■v, 

~. 

— 

— 

* 

20  30 

Years  in  Service 

Fig.  3. 


40 


50 


usual  statistical  methods,  they  indicate  that  neither  the  sinking  fund 
curve  nor  the  straight  line  represents  the  law  of  depreciation  of  the 
group  in  practice.  Two  illustrations  of  actual  depreciation  rates  have 
been  selected  and  are  here  graphically  represented. 

"Fig.  3  summarizes  experience  as  to  completed  life  in  service  of  48 
water-works  pumps  secured  by  Mr.  J.  W.  Alvord  and  published  in  the 
Proceedings  of  the  American  Water-Works  Association.  The  majority 
of  the  pumps  represented  have  been  retired  because  inadequate,  a  few 
were  discarded  because  obsolete,  and  the  remainder  scrapped. 

"No  attempt  has  been  made  in  these  illustrations  to  separate  data 
as  to  replacements  due  to  wear  and  tear  as  distinct  from  inadequacy, 


252 


VALUE  FOR  RATE-MAKING 


obsolescence  or  other  causes,  but  neither  lias  this  particularization  been 
made  in  the  usual  application  of  the  straight  line  and  sinking  fund 
theories.  When  experience  data  as  to  life  of  equipment  in  service  are 
regularly  recorded,  refinements  as  to  causes  will  probaljly  be  a  later 
development. 

"This  method  of  charting  observations  is  identical  with  that  used  by 
actuaries  in  determining  the  expectancy  of  life  of  human  beings.  Such 
experience  is  summarized  in  Fig.  4. 

100,000  ■ 

95,000 

90.000 

85.000 

80,000 

75.000 

70,000 
M  65,000 
5  60,000 
S  55,000 

E  50,000 

c 

t  45,000 
c  40,000 

35,000 

30,000 

25,000 

20,000 

15,000 

10.000 
5.000 
0 


"^ 

~, 

1    1    1    1    1    1    1    1    1    1    1    1 

s 

1    1    1    1    1    1    1    1    1    1    1    1 

s 

Humaa 

Mortality  Curve 

Oombined  Kxperience 

Institute 

of  Actuaries 

~ 

: 

s 

s 

V 

s 

S 

S 

s 

s 

s 

s 

\ 

\ 

s. 

> 

\ 

\ 

k 

\ 

V 

> 

^ 

\ 

V 

\ 

' 

V 

> 

\ 

\ 

1 

I 

\ 

s 

- 

\ 

s 

1 

V 

20 


30 


40    50 
Age 

Fio.  4. 


60 


70 


80    90 


"This  latter  curve  is  designed  to  fit  two  causes;  one,  chance  without 
previous  disposition  to  death  or  deterioration,  the  other  an  increased 
inability  to  withstand  destruction.  Life  statistics  of  utility  equip- 
ment where  the  element  of  chance  such  as  obsolescence  or  inadequacy  is 
small  and  the  gradual  deterioration  the  main  cause  of  depreciation  may 
be  expected  to  group  tliemselves  as  the  life  data  summarized  in  Fig.  4. 

"Generally,  any  life  data,  the  average  of  wliich  exceeds  the  middle 
life  value  will  result  in  a  mortality  curve  the  upper  or  concave  portion  of 
which  will  be  more  extended  than  the  lower  or  convex  portion  of  the  curve. 

"The  obvious  advantages  of  the  mortality  curve  method  of  deter- 
mining present  value  over  the  straight  line  or  sinking  fund  methods  are: 

"(a)  Every  point  is  determined  by  experience  and  where  a  large 
number  of  instances  of  replacement  have  been  utilized  to  determine 
the  character  of  the  curve,  additional  data  will  make  only  slight  modi- 


DEPRKCIA  TION 


253 


fication.     It  is  impossil)Ie  therofore  to  generalize  with  insufficient  data. 

"(b)  It  is  not  dependent  upon  an  aritlunetic  average  and  is  applicable 
to  any  age  whether  or  not  the  average  life  has  been  exceeded. 

"(c)  It  measures  the  effect  of  all  causes  of  depreciation  affecting  the 
property  and  the  effect  of  those  causes  at  any  age  upon  the  average  unit. 

"(rf)  When  sufficient  reliable  data  are  available,  it  will  permit  by 
actuarial  methods,  the  calculation  of  the  annual  reserves,  which,  with 
or  without  interest  accumulations,  as  the  case  may  be,  will  insure  the 
replacement  of  the  various  elements  of  property  at  the  end  of  their 
probable  lifetimes.  That  there  is  a  substantial  difference  between  the 
annual  reserve  required  for  a  new  property  and  that  required  for  one 
badly  depreciated,  readily  follows. 

"(e)  It  draws  the  line  sharply  between  what  is  the  rate  of  depreciation, 
the  appraisal  problem,  and  the  means  of  financing  depreciation,  the 
reserve  problem. 

"Instances  where  actual  data  as  to  life  in  service  are  available,  indicate 
that  both  the  straight  line  and  sinking  fund  curve  assume  greater  de- 
preciation rates  in  the  early  years  of  life  than  obtain  in  the  experience 
indicated  by  a  mortality  curve,  and  hence  result  in  lower  present  values. 

"Let  us  assume  for  example  that  the  mortality  of  a  unit  of  equipment 
with  an  average  age  of  20  years  follows  the  observation  as  to  life 
in  service  of  incandescent  lamps.  A  comparison  of  straight  line,  sink- 
ing fund  curve  and  mortality  curve  will  then  result  as  follows: 


Table  IX. — Remainder  Life  or  Condition  Per  Cent.  Unit  with 
Average  Life  20  Years 


At  end  of 

Straight  line, 
per  cent. 

Four  per  cent. 

sinking  fund 

curve,  per  cent. 

Mortality  curve, 
per  cent. 

2  years 

90 
80 
70 
60 
50 
40 
30 
20 
'10 
'10 
■10 
'10 
'10 
'10 
'10 

93.2 
85.7 
77.9 
69.1 
59.7 
49.6 
38.7 
26.7 
14.0 
'10.0 
'10.0 
'10.0 
'10  0 
'10  0 
'10.0 

99.4 

4  years 

97.5 

6  years 

94.5 

8  years 

90.5 

10  years 

12  years 

85.3 
79.4 

14  years 

72.7 

16  years 

65.4 

18  years 

57.8 

20  years 

50.0 

24  years 

34.6 

28  years 

20.6 

32  years 

9.5 

36  years 

2.5 

40  years 

0  0 

'  Minimum  service  value. 


254  VALUE  FOR  RATE-MAKING 

"  In  any  valuation  proceeding  wlicro  present  values  play  an  important 
part,  the  necessity  of  securing  actual  and  sufficient  data  as  to  variation  of 
life  in  service  is  evident.  Theories  which  are  generalized  from  in- 
sufficient experience  are  equitable  neither  to  the  public  utility,  the 
investor  nor  the  community."' 

Of  courso,  it  will  be  recognized  from  what  has  been  said  and 
from  the  curves  shown  by  Mr.  Gruhl  that  the  preceding  state- 
ments of  the  author  to  the  effect  that,  in  considering  any  given 
projxn'ty,  average  figures  and  curves,  compiled  from  a  large  num- 
ber of  instances,  must  be  used  with  care  and  judgment,  even 
when  applied  to  similar  articles  existing  in  large  quantity; 
furthermoro,  that  such  averages  cannot  fairly  be  applied  when 
considering  but  two  or  three  units  of  a  given  type.  Consequently, 
theoretical  depreciation,  in  determining  so-called  present  de- 
preciated value,  cannot  be  used  either  from  the  standpoint  of 
fairness,  or  from  what  it  is  practicable  for  any  accountant  or 
engineer  to  accomplish.  This  being  the  case,  the  fixing  of  values 
and  basing  of  rates  bj^  the  use  of  such  methods  is  demonstrably 
unscientific  and  illegal. 

Any  such  basis  of  ascertaining  present  depreciated  value,  as 
a  basis  of  rate-making,  is  "fanciful,"  "speculative"  and  unsup- 
ported by  "reasonable  judgment"  or  sufficient  definiteness  to 
permit  its  acceptance  by  the  Supreme  Court,  This  will  be  evi- 
denced, for  example,  by  a  comparison  of  the  values  shown  in  the 
three  columns  quoted  above  from  Mr,  Gruhl's  article.  Taking 
the  period  at  10  years  of  expired  life,  it  will  be  seen  that  under  the 
straight  line  method,  the  item  is  only  in  50  per  cent,  condition; 
under  the  4  per  cent,  sinking  fund  method,  the  value  is  almost 
10  per  cent,  higher,  or  practically  in  60  per  cent,  condition,  whereas 
under  the  mortality  curve,  it  is  in  85  per  cent,  condition. 
There  are  arguments  why  any  one  of  these  three  different  values 
should  be  assumed.  Yet  the  investor,  if  the  mortality  curve 
depreciation  is  taken,  will  be  allowed  70  per  cent,  larger  rate  of 
return  than  if  a  straight  line  assumption  were  made.  Could 
anything  be  more  absurd  and  unfair  to  the  investor!  Yet,  the 
same  property  and  the  same  investor,  if  located  in  New  York, 
under  the  ruling  of  the  Public  Service  Commission,  of  the  First 
District,  using  the  straight  line  method  would  at  the  end  of  10 
years  have  only  50  per  cent,  of  the  investment  allowed  as  a  basis 
of  fixing  the  rate  of  return;  whereas,  if  the  property  were  in 

I  •■  O.-prr-riation  KHtiiiiati-b,"  by  Edwin  (Irulil,  .4.  E.  R.  A.,  March,  1913. 


DEPRECIAriON  200 

Wisconsin,  the  llailroad  Commission  of  that  State,  using  a  4 
per  cent,  sinking  fund  curve,  would  fix  rates  on  60  per  cent,  of 
the  cost  new  value.  The  use  of  such  artificial  and  arbitrary- 
methods  of  estimating  "present  value"  is  seen,  for  example,  in 
the  change  of  chief  engineers  by  the  Wisconsin  Commission. 
Under  a  former  engineer's  direction,  80  per  cent,  was  taken  as  a 
minimum  depreciated  value  of  electric  switchboards,  and  their 
equipment;  whereas,  under  a  recent  ruling  of  the  present  engineer- 
ing force  30  per  cent,  is  now  used  as  a  minimum  value,  so  that 
simply  by  reason  of  a  change  in  the  personelle  of  the  organization, 
the  investor  now  has  his  rate  of  return  reduced  over  one-half, 
although  the  same  switchboard  and  equipment  may  be  in  use, 
and  only  a  year  or  two  older.  Is  further  argument  necessary  to 
show  that  such  widely  varying  bases  of  estimate  of  value,  de- 
pending upon  personal  judgment  and  experience,  which  varies 
widely,  as  between  different  individuals,  cannot  be  used  in 
varying  the  value  of  the  property  used  in  serving  the  public? 

The  difference  of  opinion  among  engineers  as  to  the  fair  and 
proper  annual  allowance  to  be  made  to  cover  depreciation,  and  the 
necessity  for  different  allowances  due  to  the  different  conditions 
under  which  the  physical  property  exists,  is  shown  by  the  follow- 
ing table,  which  indicates  what  is  actually  being  done  by  various 
railroad  properties: 

Table  X. — Showing  Various  Annual  Rates  Used  for  Depreciation 
OF  Rolling  Stock  Equipment,  Year  Ending  June  30,  1915' 

Road  No. 

1 — An  arbitrary  charge  of  $1,200  per  year. 

2 — 4  per  cent,  of  original  cost  less  estimated  value  of  salvage. 

3 — 6  cts.  per  car-mile  for  maintenance  and  depreciation. 

4 — 3  per  cent,  of  the  original  value. 

5 — 5  per  cent,  of  the  valuation  of  equipment. 

6 — An  arbitrary  charge  of  $3,600  per  year. 

7 — 3  per  cent,  of  record  book  value. 

8 — One  twenty-fifth  of  75  per  cent,  of  original  cost.      (Twenty-five  year 
life;  25  per  cent,  salvage.) 

9 — Arbitrary  deduction  from  income;  $500,000  per  year  for  several  years. 
10 — 1  per  cent,  of  appraised  value. 
11^2  per  cent,  of  value. 
12 — 3  per  cent,  of  cost  of  equipment. 
13—1  per  cent,  of  gross  value. 
14 — An  arbitrary  charge  of  $2,400  per  year. 

'  'Depreciation  and  Appreciation,"  by  W.  H.  Forse,  Jr.;  Electric  Railway  Journal,  Deo. 
11,  1915,  page  1169. 


2.5G  VALUE  FOR  RATE-MAKING 

15 — One  twenty-fifth  of  75  per  cent,  of  original  cost. 

16 — 5  per  cent,  of  value. 

17 — 2  p>er  cent,  of  estimated  value. 

18 — 4  per  cent,  of  estimated  cost  less  25  per  cent,  salvage. 

19 — 2 ''2  per  cent,  of  present  value. 

20 — Arbitrary  charge  of  $12,000  per  year. 

21 — 2  F>er  cent,  of  book  value. 

22 — 2^2  per  cent,  of  inventory  value. 

23 — An  arbitrary  charge  of  $1,000  per  year. 

24 — 5  per  cent,  of  appraised  value. 

25 — 6  per  cent,  of  gross  income. 

26 — 6  per  cent,  of  gross  earnings  for  maintenance  and  depreciation. 

27 — Arbitrary  charge  of  4.3  per  cent,  of  investment. 

28 — 5  f>er  cent,  of  appraised  value  less  estimated  salvage. 

29 — 10  per  cent,  of  value. 

30 — 5  per  cent,  of  estimated  value. 

31 — 2  per  cent,  of  book  cost  including  betterments. 

It  ma}'  be  noted  that  the  allowances  made  represent  an  ex- 
pectation of  life  ranging  from  10  to  100  years,  showing  the 
necessity  for  consideration  of  local  conditions  by  experienced  and 
intelligent  engineers  before  conclusions  can  be  reached  as  to 
depreciation  data. 

What  engineer  is  able  to  foretell  the  misuse  and  neglect  or  care 
and  high  degree  of  maintenance  that  any  given  apparatus  or  utility 
property  as  a  whole  will  receive,  even  during  the  next  5  or  10 
years,  with  vicissitudes  of  climate,  load  conditions,  changes  of 
management  and  requirements  of  the  pubhc?  Estimates  as  to 
the  future  life  of  utility  physical  property  must  necessarily  be 
too  tentative,  speculative  and  inexact  to  permit  fixing  definite 
and  positive  values  thereon. 

The  various  tables  published  and  ordinarily  used  by  engineers, 
as  representing  the  lives  of  physical  property,  are  based  upon 
figures  and  expenence  that  include  expiration  of  life  due  to  both 
age  and  functional  depreciation.  As  a  matter  of  fact,  the  natural 
life  of  much  physical  property  is  unknown.  The  limit  of  the 
natural  life  of  so  widely  used  property  as  cast-iron  pipe,  for 
example,  cannot  be  stated  positively  and  authoritatively,  for  in 
the  Gardens  of  Versailles,  France,  such  pipe  has  been  in  use  con- 
siderably over  200  years  and  is  still  in  excellent  condition.  Fur- 
thermore, the  expiration  of  life  due  to  functional  depreciation  is 
little  more  than  a  guess,  based  on  necessarily  limited  past  ex- 
IX'rience,  generally  involving  both  natvu'al  and  functional  de- 
preciation.    Consequently,  value  to  be  determined  by  estimates 


DEPRECIATION  257 

of  depreciation,  which  involve  knowledge  that  is  based  on  neces- 
sarily too  meager  data,  or  prophecies  that  are  merely  human 
guesses,  cannot  fairly  be  used. 

"It  is  clear  from  the  foregoing  that  the  manner  in  which  the  subject 
has  been  treated  in  the  past  is  always  an  element  of  great  importance 
in  reaching  the  conclusion  in  a  rate  case  when  a  portion  of  the  life  of 
the  property  has  expired.  If  the  company  has  consistently  proceeded 
upon  tlie  sinking  fund  theory,  it  would  be  inequitable  to  change  suddenly 
to  the  straight  line  method  of  depreciation,  and  vice  versa.     *  *  * 

"These  mathematical  computations  need  not  be  continued,  their  sole 
purpose  in  this  place  being  to  present  in  clear  form  the  fact  that  it  is 
impossible  in  a  rate  case  equitably  to  adjust  the  matter  of  depreciation 
without  considering  how  it  has  been  handled  by  the  company  in  the 
past.  If  it  has  been  handled  in  the  past  upon  the  straight  line  method, 
a  change  to  the  sinking  fund  theory  would  obviously  be  unjust  to  the 
public  and  give  greater  returns  to  the  company  than  it  is  entitled  to, 
because  an  essential  element  of  the  sinking  fund  theory  is  that  the 
company  gets  no  benefit  from  the  sinking  fund  until  the  end  of  the  term, 
and  therefore  the  return  upon  capital  must  be  continued  upon  the  full 
amount  of  the  investment  until  the  term  of  life  of  the  property  has 
expired."^ 

Perhaps  the  most  notorious  reversal  of  public  utility  commis- 
sion valuation  is  that  recently  made  by  the  Public  Service  Com- 
mission of  Washington  in  a  decision  issued  Oct.  19,  1914,  denying 
the  application  of  the  Seattle,  Renton  &  Southern  Railway 
Company  for  an  increase  of  rates.  In  its  opinion  the  Commis- 
sion says: 

"With  reference  to  the  valuation  of  right-of-way  and  terminals, 
a  rule  of  appraisal  has  been  followed  by  this  Commission  from  its  in- 
ception, and  by  the  company's  engineer  in  this  case,  with  which  the 
Commission,  as  now  constituted,  cannot  agree.  A  multiple  has  been 
used  as  a  result  of  which  the  fair  average  value  of  the  right-of-way  has 
been  doubled,  and,  in  some  cases,  trebled." 

This  change  of  front,  namely,  the  refusal  to  use  a  multiple 
in  land  values,  resulted  in  a  reduction  of  the  present  depreciated 
value  of  the  property  from  $1,601,315  to  $959,955,  or  nearly  40 
per  cent.,  due  almost  entirely  to  the  different  methods  used  by  the 
present  Commission.     Continuing  further,  the  Commission  says: 

>  Public   Service   Commission,  State   of    New  York,  Second  District,  Louis  P.  Fuhrmaii 
vs.  The  Cataract  Power  &  Conduit  Company,  decided  Apr.  2,  1913,  P.  S.  C.  R.  2d  Dist., 
Vol.  Ill,  page  720. 
17 


2o8  VALUE  FOR  RATE-MAKING 

"Shippers  and  passengers  are  now  paying  interest  upon  millions  of 
dollars  that  have  no  existence  outside  of  the  imagination  or  arbitrary- 
notion  of  a  so-called  expert."  *  *  *  "We  further  hold  that  the 
company  had  no  right  to  include  'engineering,  legal  expenses,'  etc., 
'interest  during  construction,'  'discount  and  commissions'  based  on 
this  hold-up  value  of  the  right-of-way  lands." 

It  seems  too  bad  that  newly  appointed  commissioners,  evidently 
without  experience  to  qualify  them  for  rate-making,  should  be 
unwilling  to  rely  on  the  judgment  of  experts — presumably  quali- 
fied— and  state  that  "there  is  no  logical  reason,  nor  does  justice 
demand  that  the  patrons  of  a  public  utility  pay  interest  upon  con- 
jectural expenditures  that  were  probably  never  made,"  simply 
because  they  find  that  "under  such  a  system  this  Commission 
can  never  lower  the  rate  once  established."  Commissions  are 
not  appointed  for  the  purpose  only  of  lowering  rates  without 
regard  to  justice. 

It  is,  of  course,  argued  that  such  imperfect  and  incomplete 
knowledge  as  we  have  must  be  used  in  the  estimates  of  the  life  of 
physical  property  which  are  made  the  basis  of  allowances  for 
depreciation  and  the  accruing  of  depreciation  funds.  While  this 
is  acknowledged,  it  must  be  admitted  there  is  no  practical 
objection  to  making  an  allowance  to  cover  depreciation  in  the 
future,  based  on  our  best  judgment  of  to-day,  which  allowance  it 
is  possible  and  fair  to  modify  in  the  future  by  the  amount  that 
experience  demonstrates  those  particular  allowances  to  have 
been  in  error.  This  application  of  estimating  depreciation  can  be 
made  without  injustice  to  the  public,  or  the  utility,  as  allowances 
provided  l)y  the  latter  may  be  kept  intact  and  devoted  to  their 
proper  purpose,  so  that  the  public  will  ultimately  receive  the 
benefit  in  the  future  on  any  excess  allowances  made  in  the 
present. 

There  can  be  no  question  whatever  that  in  order  to  conserve 
the  full  value  of  an  investment  in  a  wasting  asset,  such  as  phys- 
ical property,  the  amount  of  the  annual  theoretical  depreciation 
should  be  estimated  and  provided  for  out  of  revenue  each  year, 
during  the  assumed  life  of  the  physical  property.  These  aiimial 
payments  laid  aside  and  reserved  for  the  purpose  of  meeting 
the  necessary  expenditure  at  some  date  in  the  future  for  replace- 
ment, in  no  way  affects  the  absolute  value  of  the  property  render- 
ing service  to  the  public,  or  the  value  upon  which  rates  are  fixed 
or  return  to  the  investor  determined. 


DEPRECIA  TION  259 

In  fact,  the  utilities  themselves  as  a  whole  are  only  beginning 
to  appreciate  and  provide  for  all  of  those  items  of  expense  and 
future  depreciation  which  were  not  apparent  in  the  early  history 
of  corporation  service.  Even  where  these  elements  have  been 
appreciated,  the  exigencies  of  maintaining  dividends  and  sus- 
taining and  improving  the  quality  of  the  service  have  sometimes 
necessitated  the  deference  of  these  charges. 

Depreciated  Basis.  Unfair  Return. — Commissioner  Thelen  of 
California,  although  preferring  investment  cost,  rather  than 
reproduction  cost,  very  clearly  shows  the  fallacy  of  using  re- 
production cost  reduced  by  theoretical  depreciation  as  the  proper 
basis  for  determining  rates: 

"While  I  thus  find  myself  unable  to  agree  with  defendant's  argument 
with  reference  to  the  estimated  reproduction  cost  new  theory,  I  find 
that  there  is  much  merit  in  defendant's  attack  upon  the  basis  resulting 
from  the  subtraction  from  the  estimate  of  reproduction  new  of  theoret- 
ical depreciation  based  upon  mortality  tables.  Engineers  frequently 
ascertain  what  they  call  a  'per  cent,  value'  by  subtracting  from  the 
estimated  reproduction  cost  new,  an  item  for  theoretical  depreciation, 
which  is  ascertained  by  multiplying  the  average  age  of  each  class  of 
material  by  the  theoretical  depreciation  obtained  from  so-called  mor- 
tality tables.  The  basis  so  secured  may  be  just  as  unfair  to  the  utility 
as  the  basis  of  reproduction  value  new  may  be  to  the  consumer.  Thus 
a  public  utility  plant  may  originally  have  cost  $10,000.  The  money 
may  have  been  invested  honestly  and  with  a  fair  degree  of  wisdom. 
At  the  end  of  three  years  the  plant  may  be  giving  100  per  cent,  service. 
The  component  parts  have  been  correlated  and  the  system  is  in  first- 
class  working  order.  While  the  component  parts  may  not  be  intrin- 
sically as  sound  as  when  they  were  new,  it  would  be  a  foolish  waste 
of  money  to  renew  them,  for  the  reason  that  they  are  doing  their  work 
and  that  they  are  giving  100  per  cent,  service,  without  any  danger  of 
wearing  out  in  the  near  future.  Under  these  circumstances,  an  engineer 
applying  mortality  tables  and  estimating  the  theoretical  depreciation 
at  5  per  cent,  per  year,  reaches  the  conclusion  that  the  present  value 
of  the  plant  is  only  85  per  cent,  of  the  original  investment,  being  the 
sum  of  .$8,500.  The  Commission  is  accordingly  urged  to  grant  a  return 
based  on  an  estimated  present  value  of  $8,500.  If  this  return  is  allowed 
at  the  rate  of  8  per  cent.,  an  allowance  of  $680  will  be  made  for  interest. 
The  utility,  however,  has  in  good  faith  paid  out  of  its  pocket  for  capital 
account  the  sum  of  $10,000,  and  is  giving  100  per  cent,  service  to  the 
public.  What  is  to  become  of  the  remaining  $1,500  which  the  company 
has  honestly  invested?  If  a  man  loans  $10,000  on  a  first  mortgage,  he 
expects  interest  on  the  entire  sum  which  he  loans  and  expects  ultimately 


260  VALUE  FOR  RATE-MAKING 

to  get  back  his  entire  principal.  Why  should  this  same  man,  if  he 
invests  S10,000  in  a  public  utility  enterprise  and  keeps  up  his  property 
in  first-class  condition,  so  that  he  is  rendering  100  per  cent,  service,  be 
refused  a  return  on  the  difference  between  his  investment  and  a  theoret- 
ical depreciated  reproduction  value?  It  may  be  urged  that  justice  may 
be  done  by  placing  the  remaining  $1,500  in  a  depreciation  fund,  which 
fund  may  be  invested  and  bear  interest.  As  I  shall  hereafter  show, 
however,  under  the  provisions  of  section  49  of  the  Public  Utilities  Act, 
the  income  from  investment  of  moneys  in  depreciation  funds  of  public 
utilities  in  this  State  must  be  carried  in  these  funds  and  cannot  be  used 
for  the  paj'^ment  of  interest  on  investment  or  operating  expenses.  The 
injustice  of  apph'ing  such  theory  becomes  more  apparent  as  the  age  of 
materials  and  structures  increases.  If  the  theory  is  carried  to  its  logical 
conclusion  and  the  engineer  makes  no  allowance  for  repairs  and  replace- 
ments, but  confines  himself  strictly  to  the  age  of  the  structures  and  his 
mortality  tables,  there  will  come  a  time  when  the  value  of  the  prop- 
erty will  have  been  depreciated  to  zero,  so  that  no  return  whatsoever 
would  be  allowed.  While  this  maj^  be  a  fanciful  case,  it  is  of  value  in 
testing  the  accuracy  of  the  theory.  It  seems  strange  that  public  utilities, 
in  protesting  against  this  theory,  frequently  do  not  seem  to  realize  that 
the  real  reason  for  their  protest  is  that  the  apphcation  of  this  theory 
deprives  them  of  a  return  of  a  portion  of  the  money  which  they  have 
invested.  It  must  also  be  remembered  that  the  ascertainment  of  the 
physical  condition  i)er  cent,  of  a  property  is  one  thing  and  that  the 
ascertainment  of  a  proper  basis  on  which  to  give  a  return  may  be  an 
entirely  different  thing.  The  engineer  frequently  forgets  this  distinction, 
and  erroneously  believes  that  his  work  is  the  same  as  that  of  the  rate- 
fixing  authority."^ 

The  value  of  the  investment,  or  the  worth  of  the  property  in 
the  service  of  the  public  does  not  change  because  a  part  of  the 
capital  may  be  changed.  For  example:  cash  working  capital  is 
provided  as  a  part  of  the  investment. 

It  ordinarily  consists  of  cash,  materials  and  supplies.  The 
normal  and  proper  amount  of  working  capital — when  once  deter- 
mined for  a  given  corporation  at  a  given  time — is  left  unchanged 
as  a  part  of  the  value  on  which  rates  are  fixed  and  return  allowed, 
regardless  of  the  ratio  betw'cen  the  cash  and  the  physical  property 
making  up  the  total  working  capital. 

No  one  wouhl  iliink  of  deducting  the  deterioration  in  the  coal- 
pile  from  the  cash  working  capital,  and  yet  the  total  value  of 
the  fuel  depreciates  as  fast  as  it  is  shoveled  into  the  fire.     Because 

'  DecUion  of  thr-  Hailroud  ronmiission  of  California,  Town  of  Antiooh  vs.  Pacific  Gaa 
and  I'lfctric  f'oin[)any,  C'aMO  \o.  400;  J)i-ciHioii  -No.  llio.'),  July  (>,  1914, 


DEPRECIATION  261 

the  value  of  property,  having  a  hfe  extending  over  a  period  of 
years,  depreciates  very  slowly  is  no  reason  why  that  depreciation 
should  be  treated  in  any  different  way  than  short-life  property — 
such  as  fuel — which  is  exhausted  and  renewed  every  few  days. 
Everyone  recognizes  that  there  is  no  necessity  for  varying  rates 
with  the  fuel  account,  which  daily  fluctuates  in  value,  the  de- 
terioration of  which  is  charged  to  operating  expenses  as  fast  as 
it  is  consumed. 

Why  should  similar  temporary  extinguishment  of  capital  by 
the  partial  transformation  of  investment  in  the  wasting  away  of 
physical  plant  be  deducted  from  the  worth  of  the  property  used 
for  fixing  rates? 

It  has  sometimes  been  argued  that  because  for  purposes  of  sale, 
the  present  value  of  a  property  is  determined  by  deducting 
the  sum  of  both  absolute  and  theoretical  depreciation  from 
the  original  cost,  or  reproduction  new,  that  therefore  such 
present  depreciated  value  should  be  used  as  a  basis  of  rate- 
making.  The  illogic  of  such  a  proposition  will  be  evidenced  from 
the  consideration  of  value  in  connection  with  a  piece  of  real  estate. 
In  the  case  of  purchase  or  sale  of  real  estate,  carrying  a  mortgage, 
the  purchaser  pays  in  cash  the  difference  between  the  full  value 
of  the  property  and  the  mortgage,  assuming  the  obligation  for  the 
mortgage,  but  because  the  new  owner  has  paid  only  this  difference 
in  cash,  which  may  amount  to  but  one-third,  or  one-half,  of  the 
total  value,  no  one  would  argue  that  the  rent  of  the  property 
should  be  based  on  anything  but  the  sum  of  the  mortgage  and  the 
cash  payment — that  is,  the  full  value  of  the  property.  In  the 
same  way,  the  purchaser  of  a  utility  in  buying  an  operating 
property,  which  does  not  carry  with  it  a  cash  fund,  or  its  equiva- 
lent, equal  in  an  amount  to  the  estimated  depreciation,  pays  only 
for  the  present  value  obtained  by  deducting  the  sum  of  absolute 
and  theoretical  depreciation  from  the  full  value.  But  in  such 
purchase,  the  new  owner  assumes  the  obligation  to  make  good, 
when  due,  the  amount  of  all  depreciation,  which  is  equivalent 
to  a  mortgage  of  that  amount  on  the  utility.  Therefore,  the  new 
owner  is  entitled  to  earnings  and  allowances  for  depreciation 
on  an  amount  equal  to  the  sum  of  his  cash  payment,  that  is, 
the  depreciated  present  value  plus  the  depreciation  evidenced 
and  accruing  on  the  property. 

Using  the  depreciated  present  value  as  a  basis  of  rates,  the 
older,  more  decrepit  and  dilapidated  a  plant  is,  the  lower  the  rate 


202 


VALUE  FOR  RATE-MAKING 


to  the  public,  so  that  a  modern  newly  installed  plant  would  be 
unable  to  obtain  competing  business. 

If  a  depreciated  value  is  used,  as  a  basis  of  return,  instead  of  the 
investor's  being  able  to  earn  a  fair  return,  say  8  per  cent,  during 
the  life  of  the  property,  he  will  be  able  to  earn  only  an  average 
of  4.7  per  cent.,  as  shown  in  the  following  table,  where  there  is 
assumed  an  original  investment  of  $100,000  in  property,  having 
a  life  of  20  years,  depreciated  on  the  sinking  fund  basis  com- 
pounded at  4  per  cent,  annually. 

If  3.358  per  cent,  of  $100,000  =  $3,358  is  annually  laid  aside 
and  compounded  at  4  per  cent.,  this  amount  will,  at  the  end  of 
20  years  =  $100,000. 

Table  XI' 


Constant  K.  X 

8  per  cent,  on 
depreciated  value 

Age  (years) 

Constant  K. 

0.03358 
per  cent. 

Depreciated  value 

1 

1.00 

3.36 

$96,640 

$8,000 

2 

2.04 

6.85 

93,150 

7,730 

3 

3.12 

10.47 

89,530 

7,460 

4 

4.25 

14.25 

85,750 

7,170 

5 

5.42 

18.25 

81,750 

6,860 

6 

6 .  63 

22.40 

77,600 

6,. 5.30 

7 

7.90 

26.70 

73,300 

6,220 

8 

9.21 

31.15 

68,850 

5,870 

9 

10.58 

35.5 

04,500 

.5,510 

10 

12.01 

40.4 

59,600 

5,160 

11 

13.49 

45.3 

54,700 

4,770 

12 

15.03 

50  5 

49,500 

4,370 

13 

16.63 

55.8 

44,200 

3,960 

14 

18.29 

61.4 

38,600 

3,540 

15 

20.02 

67.3 

,32,700 

3,090 

16 

21.82 

73.2 

26,800 

2,615 

17 

23.70 

79.6 

20,400 

2,140 

18 

25.65 

86.1 

13,900 

1,030 

19 

27.67 

93.0 

7,000 

1.110 

20 

29.78 

100 . 00 

560 

$94,290 

It  should  be  recognized  in  any  case,  that  it  is  much  more  im- 
portant to  the  future  growth  and  welfare  of  a  utility  that  there  be 
established  a  reasonably  liberal  valuation  upon  its  property 
than  that  it  be  given  what  might  be  considered  an  excessive 
rate  of  return.     Moreover  a  utility  must  have  certain  earnings 

'  .\verage  per  cent,  on  investment    =  4.714.5  per  cent. 


DEPRECIA  TION  2()8 

to  enable  it  to  raise  additional  capital  and  if  a  commission  fails 
to  allow  full  property  values,  it  is  confronted  by  the  practical 
necessity  of  granting  a  rate  of  return  which  may  be  considerably 
in  excess  of  that  which  public  sentiment  would  approve. 

Contrary  to  a  rather  prevalent  popular  notion  and  against  the 
opinion  and  desires  of  many,  the  courts  and  commissions  are 
not  uniformly  fixing  rates  of  return  upon  the  reproduction  cost 
new  of  the  physical  property  reduced  by  theoretical  deprecia- 
tion. An  examination  of  many  decisions  rendered  shows  that 
the  value  finally  accepted  for  rate  regulation  is  an  amount 
as  large  as  the  actual  cost  or  investment  or  reproduction 
cost  new. 

The' Massachusetts  Public  Service  Commission  has  repeatedly 
taken  investment  without  deduction  for  depreciation  as  the  basis 
of  value  for  rate-making,  and  one  very  recent  decision  along  this 
line  was  handed  down  the  first  of  last  August  in  the  case  of  the 
Blue  Hill  Street  Railway  Company  operating  in  the  suburbs  of 
Boston.  The  Commission's  decision  in  this  case,  followed  the 
precedent  established  in  1914  in  the  Middlesex  &  Boston  Com- 
pany's case.  The  Blue  Hill  Company  had  been  unable,  on  ac- 
count of  small  earnings,  to  accumulate  reserves  to  offset  depre- 
ciation, the  total  deficiency  for  maintenance  and  depreciation  since 
1905,  the  Commission  found  to  amount  to  $35,341.  With  re- 
spect to  accrued  depreciation,  the  Commission  says: 

"The  extent  to  which  deduction  should  be  made  for  accrued  de- 
preciation must,  to  some  degree  at  least,  be  determined  bj^  the  method 
employed  in  ascertaining  the  gross  amount  from  which  such  deduction  is 
to  be  made.  Because  a  method  of  deahng  with  depreciation  may  be 
sound  where  such  gross  amount  represents  the  cost  of  reproduction  new, 
it  by  no  means  follows  that  the  same  rule  can  be  rigidly  applied  where 
the  'gross  amount  represents  honest  and  prudent  investment.  Under  the 
reproduction  cost  theory,  credit  is  given  to  the  company  for  apprecia- 
tion on  items  entering  into  the  estimate  of  cost  (and  often  for  'going 
concern  value'),  and  it  is  entirely  consistent  with  that  theory  to  make  a 
deduction  to  the  extent  of  existing  depreciation  on  other  items.  On 
the  other  hand,  if  a  fair  return  is  to  be  measured  by  the  'capital  honestly 
and  prudently  invested,'  and  if  no  credit  is  allowed  for  appreciation  of 
the  property  through  an  increase  in  land  values  or  higher  unit  costs  of 
material  and  labor,  it  would  hardly  seem  just  to  deduct  the  full  amount 
of  the  accrued  depreciation  under  all  the  circumstances  and  without 
reference  to  the  causes  of  the  failure  of  the  company  to  make  due  pro- 
vision for  it. 


264  VALVE  FOR  RATE-MA  KIXG 

"The  ruling  of  the  commission  in  the  Middlesex  &  Boston  case  was 
accompanied  by  the  express  stipulation  'that  if  there  is  mismanage- 
ment causing  loss,  such  loss  must  be  charged  against  the  stockholders 
legally  responsible  for  the  mismanagement.'  In  other  words,  the  com- 
pany is  held  to  tlie  same  standard  of  honesty  and  prudence  in  the  manage- 
ment and  maintenance  as  in  the  original  acquisition  of  its  properties. 
It  must,  so  far  at  least  as  it  reasonably  can,  keep  its  investment  good. 
If  through  some  fault  of  its  own  it  has  failed  to  make  due  provision  for 
dej)reciation,  it  cannot  reasonably  expect  the  public  to  pay  a  return 
upon  that  portion  of  the  investment  which  it  has  neglected  to  preserve. 
But  under  a  consistent  application  of  the  investment  theory  it  would 
seem  in  general  that  deduction  should  be  made  for  the  depreciation  which 
comes  of  age  and  use  in  so  far  only  as  the  failure  to  make  provision  for 
it  is  due  to  the  payment  of  unwarranted  dividends  or  is  otherwise 
attributable  to  mismanagement. 

"In  this  case  the  stockholders  have  received  no  dividends  whatever. 
In  view  of  the  low  earnings,  the  character  of  the  territorj^  in  which  the 
company  operates  and  its  past  and  present  efforts  to  increase  its  revenues, 
and  after  careful  consideration  of  its  history,  the  commission  is  of  the 
opinion  that  the  failure  to  make  provision  for  depreciation  and  the 
virtual  loss  of  invested  capital  caused  thereby  cannot  justly  be  as- 
cribed to  mismanagement.  To  sum  the  matter  up,  the  property  has 
depreciated  in  value  in  the  public  service,  and  the  stockholders  have 
had  no  dividends.  On  the  other  hand,  the  public  served  has  been 
receiving  transportation  at  less  than  real  cost,  and  has,  in  efifect,  used 
up  a  portion  of  the  property  without  giving  an  equivalent  in  return. 
As  stated  in  the  Middlesex  &  Boston  case,  to  hold  under  these  circum- 
stances that  the  accrued  depreciation  should  be  deducted  would  amount 
to  saying  that  money  lost  during  the  earlier  stages  of  a  public  service 
enterprise  is  irretrievably  lost  by  the  stockholders;  that  if  perchance 
rates  have  been  fixed  so  low  that  the  rate-payer  has  for  a  period  of 
years  obtained  a  service  at  less  than  cost  this  is  the  permanent  mis- 
fortune of  the  stockholders,  and  that  the  public  should  never  at  any 
time  and  under  any  circumstances  be  called  upon  to  make  up  a  deficit 
thus  incurred." 

In  conclusion  the  Board  held  that  the  Blue  Line  Company  was 
entitled  to  revenues  sufficient  to  make  an  amount  equal  to  a  fair 
return  upon  all  the  capital  honestly  and  permanently  invested 
in  the  property,  without  any  deduction  for  accruing  or  accrued 
depreciation.  That  is,  the  company  w'as  entitled  to  a  return  on 
S21,237  of  capital  funds  previously  used  for  reconstruction,  as 
well  as  the  sum  of  SI 3,750  representing  discount  on  bonds  find- 
ing a  total  value  of  the  property  of  at  least  $500,000  upon  which 


DEPRECIA  TION  2G5 

the  public  was  not  paying  the  company  a  fair  return,  and,  there- 
fore, the  Commission  authorized  an  increase  in  rates. 

It  is  encouraging  to  sec  the  later  decisions  of  commissions 
and  courts  taking  the  correct  view  of  the  treatment  of  deprecia- 
tion in  determining  the  value  of  property  upon  which  rates  are 
based.  The  Supreme  Court  of  Idaho  rendered  an  opinion  last 
summer  of  more  than  usual  interest  because  of  the  clear,  definite 
statements  made,  as  follows: 

"So  far  as  the  question  of  depreciation  is  concerned,  we  think  de- 
duction should  be  made  only  for  actual,  tangible  depreciation,  and  not 
for  theoretical  depreciation,  sometimes  called  'accrued  depreciation.' 
In  other  words,  if  it  be  demonstrated  that  the  plant  is  in  good  operating 
condition,  and  giving  as  good  service  as  a  new  plant,  then  the  question 
of  depreciation  may  be  entirely  disregarded."^ 

The  superficial  reader  of  the  Supreme  Court's  decisions,  notably 
those  in  the  Knoxville  and  Minnesota  rate  cases,  says:  "The 
Court  rules  that  depreciated  value  must  be  taken  as  the  value  for 
rate-making."  The  Court  does  so  rule;  no  one  can  take  any 
exception  to  that,  but  the  Court  further  explains  that  to  obtain 
"depreciated  value"  or  "present  value,"  it  is  necessary  "when 
an  estimate  of  value  is  made  on  the  basis  of  reproduction  new, 
the  extent  of  existing  depreciation  should  be  shown  and  de- 
ducted." If  on  these  instructions  the  expert  proceeds  to  ignore 
the  rule  that  "existing"  deterioration  should  be  deducted,  and 
proceeds  to  estimate  the  amount  of  both  "existing,"  obtained 
from  inspection,  and  "theoretical,  accruing  depreciation,"  as 
determined  from  computations,  then  taking  the  sum  of  these 
two  items  he  deducts  said  sum  from  reproduction  cost  new,  he 
has  not  followed  the  instructions  of  the  Court,  but  on  the  con- 
trary done  something  for  which  the  Court  decision  gives  him  no 
warrant. 

Theoretical  depreciation  measures  the  decrease  in  amount  of 
investment  in  perishable  property,  being  the  estimated  propor- 
tion of  the  time  that  has  expired  since  investment  was  made  to 
the  total  number  of  years  of  estimated  serviceability.  Absolute 
depreciation  depends  upon  the  existing  character  of  the  physical 
property,  the  effect  of  the  natural  elements  upon  it  and  the  care 
with  which  it  has  been  used  and  the  amounts  expended  upon  it 
for  maintenance  and  repair.     Thus,  it  will  be  seen  that  there  is 

1  Murray  vs.  Public  Utilities  Commission,  150  Pacific  Reporter  50. 


20()  VALUE  FOR  RATE-MAKING 

no  nocossaiyor  probable  reciprocal  relation  between  the  deteriora- 
tion of  investment  value  and  depreciation  of  physical  property. 

"Where  the  depreciation  is  deducted  from  the  assumed  cost  of  re- 
production new  of  the  property,  tlie  cost  of  reproduction  new  is  taken 
to  be  the  amount  of  the  original  investment,  and  then  the  assumed 
depreciation  is  deducted  therefrom  in  order  to  get  at  what  is  termed  the 
actual  vahie  of  the  propertJ^  The  question  is  whether  this  is  just  or 
unjust  to  the  company. 

"Continuing  the  use  of  the  figures,  hereinbefore  taken  as  the  basis 
of  the  illustration,  we  may  assume  that  the  property  being  investigated 
is  a  machine  which  costs  $20,000,  and  it  has  been  in  use  10  years,  and 
the  rate  is  being  established  the  eleventh  year.  The  assumed  term  of 
life  of  the  machine  is  20  years,  and  therefore  the  depreciation  is  50  per 
cent.,  and  the  value  of  the  property  in  the  public  service  is  taken  to 
be  only  S10,000. 

"Assume  that  the  case  presented  is  No.  5  above  stated,  namely,  the 
business  for  the  10  years  the  property  has  been  in  service  has  only 
yielded  the  interest  return  of  6  per  cent,  and  nothing  whatever  for  the 
destruction  of  capital.  This  is  a  common  situation.  The  first  10 
years  it  may  be  assumed  have  been  employed  in  building  up  the  business 
and  getting  it  to  a  point  where  it  would  pay  proper  returns  upon  the 
investment.  It  has  in  fact  yielded  only  $1,200  a  year,  when  it  ought  to 
have  yielded,  in  order  to  fully  reimburse  the  owners,  $  1 , 800  a  year.  Now, 
if  at  the  end  of  10  years  the  rate-making  power  decides  that  the  value 
of  the  property  in  the  public  use  is  only  $10,000,  and  makes  a  return 
upon  that  both  for  use  of  capital  and  destruction  of  capital,  the  company 
from  that  time  on  for  this  particular  machine  gets  $600  a  year  for 
use  of  capital  and  about  $335  for  destruction  of  capital.  The  clear 
result  is  that  the  company  by  this  method  of  treatment  has  absolutely 
lost  $10,000  of  its  original  investment  without  any  hope  of  return  of 
the  same  to  it."^ 

"The  depreciation  of  a  plant,  though  it  may  not  be  so  apparent,  is 
just  as  real  and  substantial  a  charge  against  revenues  as  the  wages 
paid  to  operators  or  any  other  employee  of  the  company.  For  the 
public  to  refuse  to  pay,  through  addition  to  the  rates,  a  sufficient  allow- 
ance to  guarantee  the  company  against  seeing  the  plant,  which  it  places 
at  the  disposal  of  the  public,  gradually  fritter  away  and  become  lost, 
is  unconscionable  and  inequitable.  No  just  or  fair-minded  person  any 
longer  expects  this.'"-' 

■  Public  Service  Commission,  State  of  New  York,  Second  District,  Louis  P.  Fuhrmann 
ve.  The  Cataract  Power  &  Conduit  Company,  decided  Apr.  2,  1913,  P.S.C.K.,  2d  Dist.. 
Vol.  in.  pane  721. 

'.Sixth  AiiiiiKil  Heport  of  the  Nebraska  State  Railway  Commission  to  the  Governor. 


DEPRECIATION  207 

Knoxville  Case.— The  master's  report  in  the  Knoxville  case^ 
shows  that  in  obtaining  the  vahie  of  the  property  on  which  he 
estimated  the  rate  of  return,  he  used  higher  unit  prices  than  the 
average;  he  included  over  $22,000  worth  of  service  connections, 
which  had  been  donated  by  the  water  consumers;  also  $2,000 
as  a  "contingent  allowance  for  bad  bottom,"  and  he  did  not  make 
any  deduction  for  wear  and  tear,  deferred  maintenance,  in- 
adequacy or  obsolescence,  adding  the  sum  of  both  "complete  and 
incomplete  depreciation"  to  the  estimated  depreciated  value  of 
the  surviving  plant  in  order  to  obtain  the  value  which  he  used  as 
the  basis  of  rates.  The  Supreme  Court  very  properly  criticized 
such  procedure  saying  that  it  would  obviously  "lead  to  incorrect 
results  if  the  cost  of  reproduction  is  not  diminished  by  the  dete- 
rioration which  has  come  from  age  and  use"  and  while  the  Court 
did  not  attempt  to  decide  how  much  of  the  master's  value  of  the 
tangible  property  should  have  been  diminished  by  the  deprecia- 
tion which  the  property  had  undergone,  it  did  state  it  would  be 
improper  that  "the  amounts  of  complete  and  incomplete  depre- 
ciation should  be  added  to  the  present  value  of  the  surviving 
parts"  in  order  to  obtain  the  total  plant  to  be  used  as  a  basis  of 
rate-making. 

Is  it  not  clear  that  in  this  case  the  Supreme  Court  consistent 
with  its  decision  in  the  Consolidated  Gas  case  was  pointing  out 
that  such  deterioration  as  that  resulting  from  "age"  and  "use," 
that  is  wear  and  tear,  causing  exhaustion  of  property,  also  de- 
ferred maintenance,  inadequacy,  obsolescence,  age — in  the  sense 
that  the  life  had  completely  expired — must  be  estimated  and 
deducted  from  replacement  cost  in  determining  fair  present 
value?  If  not,  and  the  Knoxville  Water  case  properly  con- 
strued means  that  present  value  is  to  be  obtained  by  deducting 
the  theoretical  depreciation  from  cost,  how  is  it  made  consistent 
with  the  decision  in  the  gas  case? 

The  term  "complete"  depreciation  in  this  case  refers  to  that 
deterioration  which  represents  "that  part  of  the  plant  which 
through  destruction,  or  obsolescence,  had  actually  perished  as 
useful  property.  The  incomplete  depreciation  represented  the 
impairment  in  value  of  the  parts  of  the  plant  which  remained  in 
existence  and  were  continued  in  use."  The  master's  report  in 
the  Knoxville  case  indicates  that  "complete"  depreciation  can 
be  determined  by  "a  detailed  examination  of  the  property  as  it 

'  City  of  Knoxville  vs.  Knoxville  Company,  212  U.  S.  1. 


208  VALUE  FOR  RATE-MAKING 

stands  to-day;"  it  must  therefore  cover  that  deterioration  due  to 
inadequacy,  obsolescence,  deferred  maintenance  or  property 
worn  out  by  "age  and  use"  and  not  actually  employed  in  the 
service  being  rendered.  It  is  these  various  classes  of  deprecia- 
tion just  specified,  and  not  theoretical  calculations  based  on 
office  records  as  to  date  of  installation  and  assumptions  as  to 
expectations  of  life  that  are  referred  to  by  the  Court,  in  the 
Knoxville  and  other  cases,  where  the  specific  statement  has  been 
made  to  that  effect  that  depreciation  must  be  deducted  in  de- 
termining the  value  of  property  to  be  used  in  fixing  rates. 

That  the  Knoxville  decision  means  all  depreciation,  both  ob- 
served or  "complete,"  as  well  as  calculated  or  "incomplete," 
must  be  deducted  from  the  cost  new  in  order  to  determine 
present  value,  has  been  insisted  upon  by  certain  courts  and 
decisions  as  the  full  and  final  conclusion  of  the  whole  matter, 
without  reference  to  or  proper  consideration  of  the  principles 
enunciated  in  the  Consolidated  Gas  decision  rendered  the  same 
day,  and  of  subsequent  decisions  more  adequately  presented  and 
better  prepared.  As  is  quite  generally  known,  the  Knoxville 
Water  Company  case  was  not  adequately  prepared,  or  well 
presented  in  comparison  with  our  present-day  knowledge  of 
these  matters,  so  that  the  resulting  decision,  with  many  of  the 
dicta  of  the  court,  has  been  taken  as  too  conclusive,  based  on 
misapprehension  of  facts  and  misinterpretation  of  the  Court's 
meaning.  With  a  more  thorough  understanding  of  the  prin- 
ciples of  valuation  and  rate-making,  subsequent  decisions  of 
the  Supreme  Court  may  be  expected  to  support  conclusions  in 
conflict  with  those  so  frequently  read  into  the  Knoxville  case, 
rather  than  in  confirmation  of  the  rather  common  interpretation 
of  the  decision  in  that  case. 

The  master's  failure  to  make  any  deduction  for  deferred  main- 
tenance, inadequacy  or  obsolescence,  adding  the  sum  of  both 
"complete  and  incomplete  depreciation"  to  the  estimated  depre- 
ciated value  of  the  surviving  plant  in  order  to  obtain  the  value 
which  he  used  as  a  basis  of  rates,  corresponded  to  taking  the 
depreciated  value  of  the  existing  property  and  adding  thereto 
the  cost  of  all  property  which  has  been  used  in  the  past  and  which 
no  longer  existed,  the  value  of  which  should  have  been  repaid 
to  the  investors  out  of  revenue  as  a  part  of  operating  expenses, 
during  the  life  of  the  now  superseded  property. 

Although  the  Supreme  Court  says  the  master  erred  in  adding 


DEPRECIATION  2()9 

the  sum  of  "complete"  and  "incomplete"  depreciation  to  the 
depreciated  present  value,  it  does  not  state  that  he  would  have 
erred  in  adding  only  "incomplete"  depreciation  to  the  depreciated 
value.  While  the  language  of  the  Court  seems  contradictory  as 
to  different  parts  of  the  decision  and  its  intent  is  not  clear  and 
logical,  the  Court  could  not  have  considered  that  adding  the 
amount  of  "incomplete"  depreciation  to  the  present  depreciated 
value  to  obtain  "present  value' ^  would  have  been  an  error,  other- 
wise it  could  not  logically  have  stated  that  renewals  must  be 
paid  for  out  of  revenue  as  part  of  operating  expenses,  for 

"if  a  different  course  were  pursued  the  only  method  of  providing  for 
the  replacement  of  property  which  has  ceased  to  be  useful  would  be  the 
investment  of  new  capital  and  the  issue  of  new  bonds  or  stock.  This 
course  would  lead  to  a  constantly  increasing  variancy  between  -present 
value  and  bond  and  stock  capitalization,  a  tendency  which  would  in- 
evitably lead  to  disaster  to  the  stockholder  or  to  the  public,  or  both."' 

It  is  evidently  the  thought  of  the  Supreme  Court  that  present 
value  and  the  amount  of  capitalization  as  represented  by  stocks 
and  bonds,  that  is,  the  investment  value,  should  correspond  or 
tend  to  equal  one  another,  which  would  not  and  could  not  be  the 
case  if  "present  value"  were  taken  to  mean  present  theoretical 
depreciated  value.     The  Court  says: 

"The  company  is  not  bound  to  see  its  property  gradually  waste, 
without  making  provision  out  of  earnings  for  this  replacement.  It  is 
entitled  to  see  that  from  earnings  the  value  of  the  property  invested  is 
kept  unimpaired,  so  that  at  the  end  of  any  given  term  of  years  the 
original  investment  remains  as  it  was  at  the  beginning." 

Could  any  statement  be  more  explicit  as  indicating  that  the 
original  investment,  if  maintained  by  necessary  maintenance 
and  renewals,  is  entitled  to  be  considered  in  determining  the  basis 
of  fixing  rates?  How,  then,  could  the  Court  hold  in  the  same 
decision  that  the  amount  of  "incomplete"  or  estimated,  theo- 
retical, not  yet  accrued  depreciation  should  be  deducted  from 
reproduction  cost  new  in  order  to  ascertain  the  basis  on  which 
to  fix  rates?  The  two  lines  of  argument  are  absolutely  incom- 
patible. Evidently,  what  the  Court  had  in  mind  was  that  the 
investment  value,  which  would  be  the  same  as  the  cost  of  repro- 
duction new  of  a  property  just  completed,  should  be  reduced 

'  City  of  Knoxville  vs.  Knoxville  Water  Company,  212  U.  S.  1. 


270  VALUE  FOR  RATE-MAKING 

only  by  the  amount  of  complete  depreciation,  the  value  of  which 
must  be  provided  out  of  earnings. 
The  decision  states  that 

"A  sufficient  amount  should  be  allowed  from  the  earnings  of  a  public 
service  corporation  for  making  good  depreciation  of  plant  and  replacing 
deteriorated  portions  thereof," 

This  is  a  mere  statement  of  a  widely  recognized,  and  generally 
acknowledged  principle  in  considering  the  distribution  of  revenue 
of  a  public  utility,  although  the  actual  application  is,  in  many 
instances,  impossible,  because  of  inadequate  revenue  and  the 
impracticability  of  raising  rates.  The  court  then  continues: 
"but  amounts  so  expended  cannot  be  considered  as  additional 
to  the  original  cost  in  valuing  the  plant  for  purposes  of  ascertain- 
ing whether  a  rate  is  confiscatory."  If  these  amounts  that  are 
to  be  allowed  and  expended  in  making  good  depreciation  are  not 
"to  be  considered  as  additional  to  the  original  cost,"  then  may 
they  be  added  to  the  present  depreciated  value  in  determining 
that  value  upon  which  rates  are  to  be  based.  The  answer  is, 
of  course,  in  the  negative;  for,  if  the  sum  of  all  allowances,  pro- 
vided and  expended  over  a  long  period  of  years,  were  added  to 
the  present  depreciated  value  of  the  property  as  found,  the  sum  of 
these  quantities  would  exceed  the  replacement  cost  new,  or  the 
"original  cost."  Consequently,  the  attempt  to  add  the  amounts 
allowed,  or  expended,  for  making  good  depreciation,  cannot  be 
used  in  any  way  in  determining  the  value  to  be  ascertained  as 
a  basis  of  fixing  rates.  For  to  attempt  to  use  such  amounts 
leads  to  reductio  ad  ahsurdimi.  The  only  logical  conclusion  then 
is  that  investment,  original  or  reproduction  new  value,  is  the 
primary  basis  to  be  used  in  fixing  rates.  But  this  value  or  basis 
is  to  be  reduced  by  the  amount  of  "complete"  or  evidenced 
deterioration  such  as  obsolescence,  inadequacy,  deferred  main- 
tenance and  the  like,  the  cost  of  which  must  be  borne  by  the 
customer  as  a  part  of  operating  expense.  Furthermore  the 
owner  must  mairitain  his  property,  providing  out  of  revenue 
derived  from  rates  a  sufficient  sum  to  take  care  of  ordinary 
operating  expenses,  wear  and  tear  and,  when  earnings  permit, 
the  necessary  replacements,  as  the  plant  becomes  exhausted 
through  "age  and  use." 

"There   is  n(<  controversy  whatever  over  the  proposition  that  the 
pul)li(t  must  pay  at  soino  time  and  in  some  form  for  tlie  property  which 


DEPRECIATION  271 

is  destroyed  or  used  in  affording  it  the  service  which  it  receives,  and 
there  is  no  controversy  over  the  fact  that  this  return  should  be  spread 
equitably  over  the  entire  life  of  the  property.  *  *  *  The  public  in 
whose  service  the  machinery  has  been  worn  out  must  pay  the  com- 
pany for  the  machinery."' 

Minnesota  Rate  Cases. — Nor  does  the  decision  of  the  Supreme 
Court  in  the  Minnesota  rate  cases  decide  that  theoretical  de- 
preciation should  be  deducted  from  reproduction  new^  to  arrive 
at  present  value  as  a  basis  for  rates.     At  page  457  the  Court 

says: 

"it  is  also  to  be  noted  that  the  depreciation  in  (juestion  is  not  that  which 
has  been  overcome  by  repairs  and  replacements,  but  is  i\m. actual  existing 
depreciation  in  the  plant  as  compared  with  the  new  one.  It  would 
seem  to  be  inevitable  that  in  many  parts  of  the  plant  there  should  be 
such  depreciation,  as,  for  example,  in  old  structures  and  equipment  re- 
maining on  hand.  And,  when  an  estimate  of  value  is  made  on  the  basis 
of  reproduction  new,  the  extent  of  existing  depreciation  should  be  shown 
and  deducted.  *  *  *  And  when  particular  physical  items  are 
estimated  as  worth  so  much  new,  if  in  fact  they  he  depreciated,  this 
amount  should  be  found  and  allowed  for." 

If  the  above  quotation  means  anything,  it  would  indicate  that 
the  depreciation  of  the  theoretical,  estimated  kind,  which  is 
normally  "overcome  by  repairs  and  replacements"  is  not  the 
kind  of  depreciation  being  considered  by  the  Court,  but  only 
"actual  existing  depreciation."  This  is  evidenced,  for  example, 
by  deduction  for  the  value  of  "old  structures  and  equipment 
remaining  on  hand,"  after  having  served  their  useful  life,  and 
held,  perhaps,  for  resale  as  scrap,  or  retained  at  full  value  in  the 
books  by  the  corporation  hoping  to  be  allowed  to  thus  artificially 
increase  the  "fair  value"  of  its  property  upon  which  the  rate  of 
return  is  to  be  allowed.  In  the  case  of  reproduction  new,  "the 
extent  of  existing  depreciation  should  be  shown  and  deducted." 
This  repeated  use  of  ^^  existing  depreciation,"  and  the  word 
"actual,"  certainly  indicate  that  class  of  depreciation  which  is 
in  evidence,  apparent  to  the  inspector,  capable  of  ascertainment 
by  examination  to  prove  that  it  is  "actually  existing"  is  what  is 
being  considered.  The  Court  expressly  further  states  that  when 
"physical  items  are  estimated  as  worth  so  much  new"  deprecia- 
tion is  to  be  deducted,  "if  in  fact  they  be  depreciated,"  and  pre- 

1  Fuhrmann  vs.  Cataract  Power  and  Conduit  Co.,  Public  Service  Coniniission  of  New 
York,  Second  District,  No.  UA,  V.  S.  C.  U.,  2d  Dist.,  Vol.  Ill,  page  71G. 


272  VALUE  FOR  RATE-MAKING 

sumably  not  otherwise.  In  the  very  nature  of  physical  property,  it 
is  impossible  after  it  has  once  been  installed  that  full  100  per  cent, 
value  can  be  represented  by  all  the  parts,  except  for  the  service 
intended.  Utility  property,  generally,  is  maintained  in  a  con- 
dition between  80  and  90  per  cent.,  depending  upon  the  particular 
kind  of  i)ropert\',  and  cannot  economically  be  maintained  in  a 
better  condition,  but  this  80  per  cent,  condition  which  can  be 
maintained  year  after  year,  indefinitely,  cannot  be  had  at  all 
without  expentling  the  100  per  cent,  of  value.  The  Supreme 
Court  states  that  depreciation  must  be  deducted  on  the  par- 
ticular physical  items  being  considered,  "if  in  fact  they  be  de- 
preciated." It  will  be  noted  the  Court  expressly  raises  the 
question  as  to  whether  there  has  been  depreciation,  or  not,  by 
the  statement  "if  in  fact  they  be  depreciated."  Absolutely,  in 
every  case,  if  market  value — regardless  of  value  for  service — was 
considered,  there  would  be  depreciation  of  physical  property 
the  instant  it  was  installed  and  there  could  be  no  "if"  in  the  case. 
The  use  of  "if"  by  the  Supreme  Court  clearly  indicates  that  de- 
preciation should  be  deducted  from  reproduction  new,  only  in 
case  deterioration  has  resulted  in  the  service  rendered  by  the 
physical  elements.  For  example,  the  installation  of  foundations 
for  a  particular  engine  are  almost  worthless  for  any  other  engine 
and  are  entirely  worthless  for  an  engine  in  any  other  location 
and,  yet,  practically  worthless  as  a  marketable  article,  no  one 
would  deny  that  the  investor  is  entitled  to  earn  a  return  on  the 
full  100  per  cent,  investment  in  said  foundation. 

If  there  is  one  thing  that  the  decision  of  the  Supreme  Court 
in  the  Minnesota  rate  cases  clearly  establishes,  it  is  that  unwar- 
ranted assumptions,  speculative  bases  and  hypothetical  conclu- 
sions will  not  be  accepted  for  facts  by  this  Court.  This  expres- 
sion of  opinion  runs  all  the  way  through  the  decision  and  clearly 
indicates  that  the  determination  of  value  by  artificial  rules, 
formulae  and  speculation,  instead  of  by  examination  of  condi- 
tions, ascertainment  of  facts  and  positive  testimony  thereon, 
will  not  have  weight  or  carry  conviction  with  the  Court.  Note, 
for  example,  the  following  quotations  from  the  decision: 

"The  ascertainment  of  that  value  (fair  value  of  the  property)  is  not 
controlled  by  artificial  rules.     It  is  not  a  matter  of  formulae.     *  *  *     " 

"The  cost  of  reproduction  method  is  of  service  in  ascertaining 
the  present  value  of  the  plant,  when  it  is  reasonably  applied  and  when 
the  cost  of  rei)roducing  the  property  may  be  ascertained  with  a  proper 


DEPRECTA  TION  273 

degree  of  certainty,  but  it  does  not  justify  the  uocoptanco  of  results, 
which  depend  upon  mere  conjecture." 

"  *  *  *  It  is  not  admissible  to  attribute  to  the  property  owned  by 
the  carriers  a  speculative  increment." 

"  *  *  *  It  is  an  increment  which  cannot  be  referred  to  an\^  criterion, 
but  must  rest  on  a  mere  expression  of  judgment  which  finds  no  proper 
test  or  standard  in  the  transactions  of  the  business  world.     *  *  *     " 

"For  an  allowance  of  this  character  there  is  no  warrant." 

Could  anything  be  more  definite  or  explicit  in  condemnation 
of  the  use  of  "formulae"  instead  of  reasonable  judgment  for 
determining  the  fair  present  value  of  property? 

The  tacit  acquiescence  and  final  acceptance  by  public  utility 
corporations  of  the  decisions  of  rate-investigating  commissions, 
fixing  the  rate  of  return  upon  the  so-called  present  depreciated 
value  of  property  being  investigated,  has  resulted  in  an  absolute 
confiscation  of  a  part  of  the  corporation's  property. 

Public  Utility  Decisions. — -That  "present  value"  as  ordinarily 
used  by  the  courts  does  not  mean  "present  theoretically  depre- 
ciated value"  is  substantiated  and  recognized  by  public  service 
commission  decisions.  The  St.  Louis  Commission  in  the  Union 
Electric  Light  &  Power  Co.  case  found  the  cost  of  reproduction  of 
the  property  on  page  64  of  their  report  to  be  $16,976,025;  there 
was  deducted  for  depreciation  $841,632,  that  is,  4.7  per  cent.,  in 
order  to  obtain  the  present  depreciated  value.  The  St.  Louis 
Commission  declared  for  the  principle  here  contended  for  in  the 
following  clear  language: 

"In  depreciating  to  arrive  at  the  present  value  of  the  depreciable 
property,  the  Commission  does  not  consider  it  fair  to  make  deductions 
for  anything  but  the  present  physical  condition,  and  for  items  where 
it  is  plainly  apparent  that  the  property  has  become  obsolete  and  in- 
adequate. The  usual  estimate  of  the  life  of  the  different  parts  of  a 
public  service  property,  so  far  as  they  deal  with  obsolescence  or  inade- 
quacy, are  extremely  problematical.  These  elements  should  not  be 
generally  taken  into  account  in  determining  the  present  value." 

Later,  the  same  Commission  rendered  a  decision  in  the  matter 
of  the  United  Railways  Company,  expressly  stating  that  it 
did  not  depreciate  the  property  in  determining  the  basis  for  rates, 
thus  following  the  precedent  it  set  in  the  case  of  the  Union 
Electric  Light  &  Power  Company. 

Still  more  recently,  Oct.  14,  1913,  the  same  Commission,  in  its 
report  on  the  Southwestern  Telegraph  &  Telephone  Co.,  reaffirms 

18 


274  VALUE  FOR  RATE-MAKING 

its  previous  rulings  on  the  question  here  being  considered,  and  at 
page  21  adds: 

''The  aim  of  regulation  should  be  protection  of  the  consumer  and 
just  treatment  of  the  investor.  If  the  investors  have  placed  a  certain 
amount  of  money  in  an  equipment  in  the  service  of  the  public  and  are 
maintaining  and  are  obliged  to  maintain  said  equipment  at  the  highest 
efficiency,  and  are  renewing  all  worn  or  obsolete  parts  as  soon  as  they 
became  unfit  for  service,  it  would  seem  that  they  are  performing  their 
full  duty  to  the  public  and  should  be  allowed  to  earn  returns  on  the 
amount  invested  in  the  public  service  for  the  equipment  in  the  service 
of  the  public,  unless  it  can  be  shown  conclusively  that  the  public  have 
paid  them  back  a  part  of  their  investment  in  the  shape  of  clearly  defined 
depreciation  charges.  Where  there  has  been  no  regulation  in  the 
past  and  where  it  can  be  shown  that  there  was  no  necessity  of  es- 
tablishing a  depreciation  fund  equal  to  the  consumption  of  estimated 
life  of  each  item  of  equipment  (see  Appendix  D,  page  122),  deduction 
for  theoretical  depreciation  in  a  rate  case  involving  a  large  'piecemeal' 
built  property  in  a  normal  and  efficient  state  becomes  in  fact  merely  a 
confiscation  of  past  profits." 

The  Board  of  Public  Utility  Commissioners  of  New  Jersey 
in  the  well-known  decision  in  the  Passaic  case  of  the  Public 
Service  Gas  Company,  where  the  Board,  commenting  upon 
the  two  methods  of  depreciation  to  determine  the  basis  upon 
which  to  figure  the  rate  of  return,  theoretical  and  absolute  de- 
preciation, adopted  the  latter  method  in  that  case,  deduct- 
ing merely  the  observed,  existing  depreciation.  The  Board 
found  the  cost  of  reproduction  new  $4,950,980,  including 
8250,000  working  capital  (cash,  materials  and  supplies),  from 
which  was  deduced  $200,980  on  account  of  depreciation,  that 
is,  4.3  per  cent.,  leaving  the  present  value  $4,750,000.  If 
depreciated  theoretical  present  value  had  been  used  by  the  New 
Jersey  Commission  a  deduction  from  the  reproduction  value  of 
the  physical  property  would  have  been  made,  amounting  to  15 
per  cent,  or  20  per  cent.,  say  $600,000  to  $800,000,  instead  of 
oidy  4.3  per  cent.,  an  amount  which  was  actually  less  than  the 
cash  working  capital  allowed.  The  Board's  measure  of  deprecia- 
tion was  a  deduction  of  such  sum  as  in  its  judgment  would  be 
sufficient,  in  their  own  language,  "to  place  a  given  property  in 
first-class  operating  condition. " 

The  (Commission  expressly  rejected  the  theoretical  method  of 
arriving  at  the  depreciation  that  should  be  deducted  from  repro- 
ductioii  cost  new  as  a  basis  of  rates. 


DEPRECIA  Tl  ON  275 

The  Public  Utility  Commission  of  New  Jersey,  following 
the  principles  adopted  in  the  Passaic  Gas  case,  that  deduction 
for  depreciation  should  be  based  upon  inspection  rather  than 
theoretical  amounts  computed  from  estimates  of  expected  life, 
held  in  the  case  of  the  Delaware  &  Atlantic  Telegraph  &  Tele- 
phone Company: 

"The  magnitude  of  the  utility's  responsibility  is  therefore  the  sum 
of  the  unexpired  service  value  of  tangible  property  plus  the  pecuniary 
liability  to  make  replacements  as  needed  from  its  own  pocket.  As  its 
responsibility  is  measured  by  a  sum  in  excess  of  the  unexpired  service 
value  of  its  tangibles,  it  would  seem  to  us  that  the  equitable  base  upon 
which  it  is  entitled  to  a  return  is  in  excess  of  the  unexpired  service  value 
of  its  apparatus,  and  approaches  as  a  limit  the  total  replacement  cost 
new  of  its  tangible  property. 

"On  the  other  hand  it  would  appear  that  an  allowance  of  replacement 
cost  new  of  tangibles  as  the  base  on  which  a  return  is  to  be  allowed 
(so  far  as  tangible  property  is  concerned)  might  in  certain  circumstances 
be  excessive.  In  comparison,  for  example,  with  a  utility  which  has 
to-day  in  its  plant  tangible  property  of  a  service  value  equal  to  the 
service  value  new  of  its  original  investment  in  tangibles,  or  which  has 
accumulated  a  fund  sufficient  at  any  time  to  replace  in  full  the  expired 
service  value  of  its  tangibles,  the  utility  which  has  done  neither  of  these 
things  but  simply  lies  under  the  naked  obligation  to  make  such  replace- 
ments as  required,  is  less  meritorious  and  is  deserving  of  somewhat  less 
allowance  in  the  base  for  return.  There  is  a  greater  assurance  in  the 
former  case  than  in  the  latter  of  prompt  and. adequate  addition  of 
needed  items  when  without  such  additions  a  service  of  100  per  cent, 
efficiency  would  be  lacking."   *  *  * 

"While  we  are  not  confident  that  in  the  Knoxville  Water  case  the 
Supreme  Court  of  the  United  States  had  before  it  any  record  of  each 
and  every  consideration  properly  to  be  considered  in  the  matter  of 
making  deductions  from  the  replacement  value  new  of  tangible  property, 
it  is  tolerably  clear  that  this  deduction  or  abatement  here  proposed  is 
wholly  in  keeping  with  the  valuation  rule  that  seemingly  may  be 
deducted  from  that  opinion.  Such  abatement  or  deduction  is  only  a 
fraction  of  the  total  expired  service  value  of  tangible  property  in  this 
particular  case.  This  moderate  reduction  has  also  this  advantage: 
that  it  is  based  upon  certainly  ascertained  inspection  or  investigation, 
and  not  upon  the  more  or  less  conjectural  allowances  for  depreciation 
estimated  by  tables  purporting  to  give  the  expectation  of  life  of  various 
parts  of  the  utiUty's  plant. "^ 

1  Report  and  Order  of  Board  of  Public  Utility  Commissioners,  in  the  matter  of  Gately 
and  Hurley  et  al.  vs.  Delaware  and  Atlantic  Telegraph  and  Telephone  Company,  de- 
cided January  7,  1913. 


276  VALUE  FOR  RATE-MA  KING 

The  New  York  Public  Service  Commission,  in  Nos.  154  and 
156  (the  Buffalo  cases),  found  present  value  to  be  the  investment 
made  by  the  owners,  plus  the  unearned  increment  on  real  estate. 

''Updu  this  assumption  it  is  absolutely  just  to  tlie  public  and  to  the 
company  to  compute  the  annual  return  for  use  of  capital  upon  the  basis 
of  the  investment,  and  so  long  as  the  company  continues  to  give  good 
service  it  will  be  entitled  to  an  annual  return  upon  that  amount,  be- 
cause that  is  what  it  has  in  the  business."^ 

The  Public  Service  Commission  of  Nevada,  in  the  Ely  Light 
&  Power  Company  decision,  recently  decided  that  present  value 
was  the  cost  of  reproduction  new  despite  the  arguments  advanced 
by  some  as  to  the  decision  of  the  Supreme  Court  in  the  Minnesota 
rate  cases.  The  Commission  distinguishes  the  Minnesota  cases, 
where  the  question  at  issue  was  whether  the  rates  were  con- 
fiscatory, from  the  ordinary  and  usual  case  of  establishing  fair, 
just  and  reasonable  rates.  The  Commission  states  that  the  Court 
in  that  case 

"nowhere  lays  down  the  rules  that  in  the  actual  work  of  rate-making, 
the  body  which  is  invested  with  such  power  must  consider  only  the  de- 
preciated value.  It  does  not  follow  that  when  such  a  body  makes  a 
reduction  in  rates,  it  must  cut  to  the  very  lowest  point  at  which  the 
rates  as  prescribed  would  be  sustained  by  a  court.  *  *  *  In  regulat- 
ing public  service  utilities  there  is  much  to  be  considered,  separate  and 
apart  from  the  mere  question  of  rates.  While  it  is  well  settled  that 
the  rates  shall  be  reasonable,  the  question  of  their  reasonableness  is 
to  be  determined  by  a  consideration  of  every  fact  and  circumstance 
which  has  a  bearing,  and  also  by  a  consideration  of  the  principles  of 
sound  public  policy." 

The  Nevada  Commission  fixed  rates  and 

"reached  its  conclusion  on  the  basis  of  the  reproduction  value  (new) 
of  the  company's  property  *  *  *  after  having  added  to  the  unit  cost 
prices  of  their  engineer,  made  up  on  the  basis  of  reproduction  value 
new,  an  additional  20  per  cent.  *  *  *  for  cost  of  engineering,  super- 
intendence, contingencies  and  interest  during  the  construction  of  the 
plant." 

In  the  case  of  City  of  Helena  vs.  The  Helena  Light  &  Rail- 
way Company,  Public  Service  Commission  of  Montana,  decided 
Nov.  3,  1913,  Sixth  Animal  Report,  194,  at  page  196,  the  Com- 

'  Public  Sorvico  Commission,  State  of  \ew  York,  Second  District,  Louis  P.  Fulirniann 
VB.  The  Cataract  Power  &  Conduit  Company,  decided  Apr.  2,  1913,  P.  S.  C.  R.  2d  Dist., 
Vol.  Ill,  pugf  723. 


DEPRFAIA  TJON  277 

mission,  after  finding  that  the  cost  of  reproduction  new  of  the 
physical  property  amounted  to  $250,000,  says: 

"Whether  or  not  the  valuation  thus  obtained  is  subject  to  deprecia- 
tion and,  if  so,  to  what  extent,  is  a  matter  of  expert  opinion,  depending 
upon  the  amount  expended  for  maintenance,  renewals,  and  permanent 
improvement  work,  the  period  during  which  such  amounts  were  ex- 
pended and,  in  general,  the  'state  of  repair'  of  the  property.  It  will  be 
obvious  that  there  can  be  no  fixed  percentage  of  depreciation  applicable 
to  a  utility  that  had  been  'kept  up'  from  year  to  year  by  constant 
effort,  and  the  purchase  of  improved  devices,  as  compared  with  one 
that  had  been  allowed  to  deteriorate  through  neglect;  hence  the  prin- 
ciple of  an  arbitrarily  established  measure  of  depreciation  is  untenable. 

"Assuming  that  rates  were  being  made  for  a  new  plant,  it  would  be 
the  total  capital  that  must  be  considered  as  entitled  to  bear  interest, 
as  there  would  be  no  accrued  depreciation.  Depreciation  is  a  liability 
against  the  allowance  for  future  depreciation  which,  it  is  assumed, 
has  been  taken  care  of.  To  simplify  the  matter,  let  us  assume  that  an 
investment  is  made  in  1903  of  $100,000  under  a  20-year  franchise,  rate 
of  interest  allowable  10  per  cent,  per  annum,  and  figuring  5  per  cent,  per 
annum  depreciation.  At  the  end  of  10  years,  or  in  1913,  the  property 
will  have  depreciated  $50,000  and  has  a  remaining  value  of  a  like 
amount.  Then  if  rates  are  made,  based  on  the  depreciated  value, 
they  must  be  one-half  of  the  original  rates,  although  the  service  may  be 
just  as  efficient  as  it  ever  was,  and  in  10  years  more  the  physical  value 
of  the  plant  would  be  nil,  and  likewise  upon  the  same  basis  of  reason- 
ing, the  utility  would  not  be  permitted  to  charge  anything." 

The  Wisconsin  Commission,  in  Fullmer  vs.  Wausau  Street 
Railway  Company,  5  W.  R.  C.  R.  114,  at  page  127,  says: 

"If  the  present  value  exclusively  were  to  be  taken  as  a  basis,  re- 
spondent would  not  receive  credit  for  having  installed  any  part  of  its 
plant  at  full  cost.  The  present  value,  as  of  June  30,  1908,  must,  there- 
fore, be  increased  by  the  amount  of  the  estimated  depreciation  on  that 
part  of  the  plant  which  the  company  installed  new." 

The  same  Commission,  in  Hill  et  al.  vs.  Antigo  Water  Co., 
3  W.  R.  C.  R.  623,  says: 

"Of  the  physical  plant  alone,  the  most  equitable  valuation  for  rate- 
making  purposes  appears  to  be  best  represented  by  the  original  cost 
of  the  plant  and  by  the  cost  of  reproducing  it." 

The  same  Commission,  in  City  of  Whitewater  vs.  Whitewater 
E.  L.  Co.,  6  W.  R.  C.  R.  132,  at  page  138,  says: 


278  VALVE  FOn  RATE-MA  KIXC 

"As  it  is  a  general  rule  that  the  reasonable  return  which  a  utility  is 
allowed  to  earn  covers  interest  and  depreciation  on  the  actual  invest- 
ment in  the  plant,  it  becomes  important  to  know  what  the  investment 
in  the  plant  actually  is,  that  is,  what  is  the  value  of  the  plant  new.  The 
fact  that  the  property  of  the  utility  has  diminished  in  value  with  use, 
as  the  inevitable  result  of  depreciation,  does  not  lessen  the  amount  of 
the  investment  in  the  plant  for  rate-making  purposes." 

The  Public  Utilities  Commission  of  Connecticut  has  fully 
accepted  the  theory  here  contended  for  in  the  case  of  Herbert  0. 
Bowers  et  al.  vs.  Connecticut  Company,  Docket  No.  8,  page 
11,  as  follows: 

"We  do  not  think  that  the  original  cost  of  construction,  whatever 
that  may  have  been,  the  price  paid  for  the  line  by  the  Connecticut 
Company,  whether  exorbitant  or  otherwise,  or  any  inflated  value  for 
the  issue  of  stocks  or  bonds  are  proper  standards  to  determine  the  value 
of  the  plant  and  equipment  for  which  the  company  is  entitled  to  receive 
a  fair  income;  but  the  cost  of  reproduction  at  the  present  time  in  this 
particular  case  is  a  more  accurate  standard,  and  the  one  which  the 
Commission  has  followed  in  determining  such  value." 

Individual  Opinion. — Commissioner  Erickson,  of  the  Wisconsin 
Commission,  in  his  paper  before  the  Indiana  Sanitary  and  Water 
Supply  Association,  dated  Feb.  15,  1912,  on  page  10  says: 

"When  the  plants  are  constructed  to  meet  public  needs  and  when 
deemed  as  of  great  or  of  greater  value  than  their  cost;  when  those  who 
furnish  the  capital  did  so  in  good  faith;  and  when  ordinary  judgment 
was  used  in  all  matters  pertaining  to  the  undertaking,  then  it  would 
seem  that  there  is  little  room  for  questioning  the  fairness  of  the  actual 
cost." 

And  again,  at  page  24: 

"Cost,  both  reproduction  and  the  original,  as  explained  herein,  for 
industries  where  monopoly  conditions  obtain,  represent  the  rights  of 
the  investors  and  the  obligations  of  the  consumers  and  furnish  equitable 
bases  upon  which  to  adjust  the  relations  as  between  these  two  classes." 

And  again,  at  page  37,  of  the  same  paper: 

"On  the  whole  the  value  that  is  just  to  both  investor  and  customer 
is  that  value  which  is  represented  by  costs.  A  reasonable  valuation  of 
the  sacrifices  involved  in  furnishing  the  service  constituted  the  fairest 
basis  for  just  charges.  Upon  this  amount  the  investors  are  ordinarily 
entitled  to  reasonable  returns.  The  cost  appears  to  be  the  best  and 
safest  basis,  not  only  for  valuation,  but  for  earnings  or  rates. 

"Hill  d  nl  vs.  Antigo  Water  Co.  (1909),  3  W.  R.  C.  R.  G23. 


DEPRECIA  TION  279 

In  re  Menominee  &  Marinette  Light  &  Traction  Co.  (1909),  3 
W.  R.  C.  R.  778. 

State  Journal  Printing  Co.  et  al.  vs.  Madison  Gas  &  Electric  Co. 
(1910),  4  W.  R.  C.  R.  501. 

City  of  Milwaukee  vs.  Milwaukee  Gas  Light  Co.  (Aug.  14,  1913), 
12  W.  R.  C.  R.,  No.  U-234." 

Mr.  Cromwell,  chief  engineer  of  the  New  York  Public  Service 
Commission,  Second  District,  in  the  Westchester  Lighting 
Company  case  testified  as  follows: 

"As  a  general  proposition  in  considering  depreciation,  it  must  be 
remembered  that  the  respondent  is  required  to  furnish  100  per  cent,  of 
service,  with  the  plant  as  it  exists,  and  is  entitled  to  a  fair  return  upon 
100  per  cent,  of  investment  value"  (page  6). 

Q.  It  doesn't  make  any  difference  to  the  consumer  whether  the  gas 
main  supplying  his  premises  is  one  year  old  or  fifty,  assuming  them  to 
be  equally  efficient? 

A.  Not  if  satisfactory  and  adequate  service  is  rendered. 

Q.  It  doesn't  make  any  difference  to  the  consumer  whether  the  holder 
in  which  the  gas  which  he  consumes  is  stored,  is  five  years  old  or  thirty, 
assuming  an  unimpaired  service  value? 

A.  Not  if  satisfactory  and  adequate  service  is  rendered. 

Q.  Does  the  failure  of  the  owner  of  the  property  to  lay  aside  reserve 
for  the  replacement  of  property  in  any  way  affect  the  consumer? 

A.  Not  if  satisfactory  and  adequate  service  is  rendered"  (pages 
3122-3). 

Prof.  George  F.  Swain,  engineer  of  the  Massachusetts  Joint 
Commission,  established  in  1910  to  ascertain  the  relation  between 
existing  capitalization  and  property  value  in  the  case  of  the 
New  York,  New  Haven  &  Hartford  Railway  Company,  in  his 
report,  says: 

"If,  then,  the  company  is  to  keep  its  railroad  as  good  as  new,  so  far 
as  operating  is  concerned,  or  perhaps  in  view  of  what  has  previously 
been  adduced  better  than  new,  charging  the  cost  of  repairs  and  renewals 
in  kind  to  operating  expenses,  it  certainly  ought  to  be  allowed  a  capital 
corresponding  and  to  charge  rents  sufficient  to  allow  of  such  repairs  and 
renewals.  It  is  the  duty  of  the  railroad  company  to  maintain  this 
property  practically  as  good  as  new,  and  the  State  has  power  to  compel 
the  owners  of  the  property  to  do  so.  Portions  which  are  worn  out  must 
be  replaced  out  of  operating  expenses,  and  for  the  purposes  of  operation 
the  property  is  always  as  good  as  new.  If,  therefore,  the  valuation  is 
for  the  purpose  of  justifying  rates  or  capital,  100  per  cent,  valuation 
should  be  taken." 


280  VALUE  FOR  RATE-MAKING 

Mr.  Bion  J.  Arnold,  an  engineer  of  national  reputation,  a  man 
who  has  been  much  employed  by  the  public,  by  many  of  the 
principal  cities  as  Chicago,  New  York,  San  Francisco,  Cincinnati, 
Toronto,  etc.,  in  a  statement  made  by  him  before  the  American 
Institute  of  Electrical  Engineers,  in  1911,  takes  the  position  that 
the  "fair  rate  of  return"  should  not  be  based  upon  the  depre- 
ciated value  of  the  property,  in  the  following  language: 

"I  maintain  and  always  have,  when  you  are  considering  a  question 
of  rate-making,  that  the  company  asking  for  the  rate  should  be  allowed 
a  rate  based  upon  the  cost  to  reproduce  the  property  new,  taking  into 
consideration  the  development  expenses  which  I  have  mentioned,  and 
that  a  condition  precedent  to  that  valuation  requires  the  property 
to  be  in  first-class  condition  so  as  to  be  able  to  give  first-class  service 
and  if  the  property  is  found  to  be  in  bad  physical  condition,  that  the 
company  has  no  right  to  ask  that  the  rate  be  based  on  the  cost  to  re- 
produce new,  unless  the  company  has  in  its  treasury,  or  has  somewhere 
a  depreciation  reserve  fund,  such  as  we  have  in  Chicago,  provided  of 
course  it  has  been  able  to  earn  such  a  fund  sufficient  to  put  the  property 
in  first-class  condition,  so  as  to  give  a  first-class  service,  which  is  what 
you  require  of  it,  and  which  is  the  condition  you  require  it  to  be  kept 
up  to  in  order  to  entitle  it  to  the  rate  you  give  it. 

"Many  communities  will  attempt  to  fix  a  rate  upon  the  depreciated 
value  of  the  property.  I  think  that  is  a  short-sighted  poHcy  from  the 
standpoint  of  the  public,  because  if  the  rate  is  fixed  on  that  value  the 
company  has  no  chance  to  raise  enough  capital  to  put  its  property  in 
first-class  condition,  to  give  first-class  service,  and  consequently  the  rate 
should  be  based  upon  the  capitahzation  to  reproduce  the  property  new." 

Dr.  Alexander  C.  Humphreys,  a  leading  consulting  engineer 
and  a  practical  operator  of  utiUties,  who  is  recognized  as  a  noted 
student  of  the  questions  here  being  considered,  said: 

"Finally,  nothing  that  I  have  said  as  to  the  determination  of  actual 
'depreciation'  is  to  be  taken  as  an  admission  that  in  a  ftite-fixing  case 
any  deduction  should  be  made  from  the  appraised  cost  to  reproduce 
plant  new  to  cover  so-called  accrued  depreciation,  or,  more  correctly 
speaking,  the  accrued  liability  against  the  stockholders  for  final  renewals 
or  replacements.  This  is  a  liability  resting  against  proprietors;  and 
they  must  be  given  the  normal  opportunities  to  meet  this  liabihty 
without  in  the  meantime  suffering  confiscation  of  investment  by 
anticipation  of  the  dates  when  the  several  payments  to  meet  this 
liability  may  fall  due." 


DEPRECIATION  281 

"To  me  it  is  clear  that  in  appraising  the  ph^ysical  portion  of  a  property 
to  determine  its  measure  in  capital,  no  further  deduction  for  deprecia- 
tion should  be  made  than  is  measured  by  the  cost  of  restoring  the  parts 
to  their  full  efficiency  for  production,  and  therefore  that  its  condition  as 
to  obsolescence,  inadequacy,  and  physical  decay  and  not  its  age  should 
determine  the  deduction,  if  any,  to  be  made.  If  there  is  an  accrued 
depreciation  in  excess  of  the  actual  depreciation  found  as  above,  the 
cost  of  renewal  must  be  paid  for  from  income.  In  the  long  run  no  in- 
justice is  so  done  to  the  consumer  of  the  product,  because  the  consumer, 
first  or  last,  should  pay  for  the  maintenance  of  the  plant  at  its  original 
cost,  provided  the  profits,  whether  paid  out  in  dividends  or  carried  into 
surplus,  are  not  found  to  be  unfair;  which  is  the  very  question  at  issue 
and  to  be  determined  in  these  rate  cases.     *  *  * 

"  In  the  appraisal  of  a  plant  to  determine  the  investment  upon  which  a 
'fair  return'  (whatever  that  may  be  determined  to  be — varying  with 
the  general  and  local  conditions)  is  to  be  calculated,  it  is  not  by  any 
means  clear  to  me  that  there  should  be  any  deduction  for  depreciation 
provided  the  plant  is  found  to  be  in  a  condition  to  render  efficient  ser- 
vice to  the  public.  Certainly  no  such  deduction  should  be  made  if  the 
income  has  not  been  sufficient  to  maintain  the  plant,  provide  for  ac- 
cruing depreciation,  and  afford  a  fair  return  on  the  investment."^ 

Illustrations. — It  would  seem  that  however  useful  estimates  of 
life  of  property  may  be  in  establishing  annual  rates  of  deteriora- 
tion, for  accounting  purposes,  theoretical  depreciation  has  no 
place  in  determining  the  basis  for  fixing  rates  of  return.  If  so, 
by  what  method  is  theoretical  depreciation  to  be  determined? 
At  which  month  in  the  life  of  the  physical  property  which  ex- 
tends over  years  is  the  present  value  to  be  estimated?  Assume 
that  the  life  of  a  large  part  of  a  complete  property  is  20  years, 
then  at  the  end  of  19  years  and  6  months,  if  theoretical  deprecia- 
tion is  considered,  the  present  value  of  the  property  would  be 
small  and  the  rates  based  thereon  would  include  nothing  in  the 
way  of  return  on  a  large  part  of  the  property,  still  100  per  cent, 
useful,  a  ye,ar  thereafter  the  property  being  entirely  replaced 
and  new,  the  rates  would  be  incomparably  higher  and  between 
these  two  extremes,  the  rates  will  fluctuate  depending  on  the 
year  or  the  month  in  which  the  present  value  is  estimated.  Con- 
sider two  surface  railways  running  out  parallel  avenues  from  the 
center  of  a  city  to  the  suburbs,  both  alike  in  construction  but  one 
10  years  old  and  the  other  put  in  operation  within  a  year.     If 

'  Lecture  Notes  on  Business  Engineering  by  Alex.  C.  Humphreys;  Second  Edition,  1912. 


282  VALUE  FOR  RATE-MAKING 

theoretical  depreciation  is  considered  the  present  vahics  of  these 
two  properties  are  quite  different,  the  older  road  being  worth 
appreciably  less  than  the  new  road,  although  the  original  cost 
of  installation  may  have  been  the  same  in  both  cases.  Under 
such  circumstances,  is  the  older  road  to  be  allowed  to  charge 
only  a  4-ct.  fare,  assuming  that  that  gives  a  fair  return  on  the 
estimated  present  value,  while  the  new  road  must  charge  a  5-ct. 
fare  for  the  same  return  on  its  estimated  value?  What  would  be 
the  result  practically  of  such  method  of  fixing  rates?  The  old 
road  would  be  swamped  with  business  and  the  new  road  would  be 
unable  to  maintain  its  earnings.  Again,  the  theoretical  present 
value  of  the  property  of  a  lighting  company  might  be  found  to  be 
50  per  cent,  of  the  cost  new  but  such  value  would  not  properly 
represent  its  worth  in  service  to  the  public  because  it  would  prob- 
ably be  in  such  poor  condition  that  continuous  and  satisfactory 
service  could  not  be  rendered  and  the  real  worth  and  service  to 
the  public  would  be  very  much  below  50  per  cent.  On  the 
other  hand,  through  extravagant  management,  and  the  replacing 
of  partly  worn  out  apparatus  before  economically  necessary  and 
the  incurrence  of  abnormally  high  maintenance  charges  in  order 
to  maintain  the  theoretical  present  value  of  the  property  at  say 
90  or  95  per  cent.,  there  would  result  unnecessarily  high  operating 
expenses  and  unwarrantable  charges  upon  the  public  merely 
for  the  sake  of  maintaining  a  theoretical  high  present  value  on 
which  a  fair  rate  of  return  must  be  allowed.  A  property  of  this 
kind  maintained  at  an  abnormally  high  present-value  worth, 
would  be  of  no  greater  service  to  the  public  than  one  of  which  the 
present- value  worth  might  be  only  75  per  cent.,  whereas  the 
burden  to  the  public  in  maintaining  the  former  property  would 
be  very  much  higher  than  the  latter.  Can  such  fanciful  and 
variable  bases  be  intended  by  the  Supreme  Court  to  be  taken 
as  that  on  which  rates  are  to  be  estimated  and  regulated?  Such 
conclusion  would  be  illogical,  unreasonable  and  unfair.  Pro- 
vided a  property  is  kept  in  good  order  and  at  100  per  cent,  work- 
ing efficiency  so  as  to  render  service  to  the  public  equivalent  to 
that  of  a  new  plant,  the  question  of  rates  or  value  of  property 
in  its  service  to  the  public  has  absolutely  nothing  to  do  with  the 
amount  of  reiserve  funds  the  corporation  may  or  may  not  have 
accumulated.  The  value  of  any  physical  property,  as  must 
of  course  be  recognized,  has  no  relation  whatever  to  the  amount 
of  money  a  corporation  may  have  to  its  credit  in  the  bank, 


DEPRECIATION  283 

nor  have  rates  for  service,  as  far  as  we  have  ever  heard,  been 
based  on  the  amount  of  a  company's  surplus  or  reserve  funds. 

"The  writer  has  before  him,  profossionally,  an  estimate,  made  by 
an  engineer  of  a  State,  of  the  present  vahie  of  a  Hne  of  raihvay.  This 
raihvay  was  constructed  as  one  task  within  a  period  of  about  two  years, 
and  cost  about  $5,000,000.  The  property  was  operated  for  some  special 
traffic  during  construction.  The  valuation  was  made  as  of  a  date  about 
20  months  after  the  road  was  turned  over  to  the  operating  department. 
The  State  engineer  finds  its  original  cost  and  its  reproduction  cost;  and 
tlien  he  estimates  the  'condition  per  cent.'  of  each  item  of  physical 
property,  and  averages  them  for  the  total,  with  the  result  that  he  esti- 
mates the  present  value — the  value  on  which  the  owner  is  entitled  to  a 
return  without  interference  by  the  State — as  95  per  cent,  of  the  amount 
of  present  cost  of  the  property.  If  the  property  actually  and  reasonably 
cost  $5,000,000  two  years  before  this  valuation  was  made,  and  could 
reasonably  be  reproduced  at  the  time  of  the  valuation  for  not  less  than 
that  amount,  as  might  well  be  assumed,  then,  if  the  owner  shall  be 
limited  at  the  time  of  the  valuation  to  a  return  on  only  $4,750,000,  it 
seems  to  be  clear  enough  that  somewhere  he  has  wholly  lost,  or  has  at 
least  lost  the  valuable  use  of  $250,000.  There  is  no  force  in  the  sugges- 
tion that  he  is  entitled  to  earn  and  lay  aside  this  $250,000  during  this 
period  of  two  years  in  which  depreciation  is  alleged  to  have  accrued. 
Even  if  he  shall  be  able  to  earn  it,  he  may  not  consider  it  as  a  return 
of  a  part  of  his  investment  and  devote  it  to  his  private  use  as  such. 
He  is  under  exact  obligation  to  use  it  in  replacing  the  depreciating  articles 
when  they  shall  have  depreciated  to  the  point  of  ineffectiveness  (italics 
are  the  author's).  In  other  words,  because  the  proper  maintenance 
of  the  property  is  the  very  first  charge  against  the  earnings  of  a  railroad 
company,  and  because  the  property  must  be  maintained  ordinarily  in 
perpetuity,  money  properly  necessary  for  replacement  of  portions  of  the 
property  when  they  shall  have  depreciated  into  inefficiency,  and  reserved 
by  the  company  for  that  purpose,  may  just  as  well  be  said  to  be  devoted 
to  the  public  use  as  may  the  physical  property  of  the  company  actually 
used  in  operation.  It  may,  perhaps,  be  invested  by  the  company  until 
the  necessity  for  its  use  arises,  but  if  the  investment  proves  unfortunate 
and  the  money  is  lost,  it  must  be  replaced,  and,  apparently,  at  the  ex- 
pense of  dividends  which  otherwise  might  l)e  properly  payable;  and,  if 
the  depreciation  fund  is  invested  and  produces  income,  of  course  that 
income  ought  to  be  included  in  the  general  income  of  the  company 
on  the  net  of  which  the  reasonableness  of  its  rate  of  return  is  to  be 
figured."^ 

'  Jared  How,  Esq.,  Proceedings  of  the  American  Society  of  Civil  Engineers,  Vol.  XL,  No. 
2,  February,  1914. 


284  VALUE  FOR  RATE-MAKING 

Until  comparatively  recently,  practice  has  paid  too  little  atten- 
tion to  the  necessary  allowance  to  be  made  for  the  element  of 
depreciation.  In  order  to  show  net  earnings  that  would  main- 
tain the  credit  of  the  utilities,  or  warrant  the  issuance  of  addi- 
tional securities,  or,  in  some  comparatively  few  instances,  to 
permit  payment  of  unwarranted  dividends,  only  that  part  of  the 
total  depreciation  annually  observed,  namely,  wear  and  tear, 
has  been  provided  for;  the  remaining  portion  of  depreciation, 
namely,  renewals  and  replacements,  future  inadequacy  or  obsoles- 
cence, the  demand  for  which  was  not  yet  apparent,  has  been  de- 
ferred perhaps  without  full  appreciation  of  the  fact  that  theo- 
retical depreciation  must  eventually  be  provided  for  just  as  surely 
as  ordinary  maintenance  expenses,  if  the  property  is  to  be  con- 
tinuously maintained  in  first-class  operating  condition. 

"The  question  whether  depreciation  is  a  proper  operating  charge 
is  no  longer  open  to  debate.  The  opinion  of  Mr.  Justice  Moody, 
already  cited,  reflects  the  generally  recognized  rule  that  rates  should  be 
sufficient  to  permit  current  repjairs  to  be  made,  parts  to  be  replaced, 
and  other  charges  met,  so  that  by  one  means  or  another  the  investment 
may  be  kept  unimpaired.  In  order  that  this  object  may  be  attained, 
every  part  of  the  property  must  be  considered,  and  wherever  there  is 
decrease  in  value,  provision  must  be  made  for  an  off'set  in  one  form 
or  another."^ 

Of  course,  this  estimated  cost  of  future  renewals  is  as  much  a 
part  of  the  annual  operating  expense  as  is  the  cost  of  wages,  fuel, 
current  repairs,  taxes,  or  interest,  and  if  not  included  in  the  annual 
expense,  the  net  profits  are  incorrectly  stated.  Due  largely  to  the 
demands  of  the  public  for  reduced  rates,  and  the  insistence  on 
the  part  of  regulatory  bodies  that  utility  properties  be  maintained 
in  first-class  operating  condition,  there  has  recently  resulted 
general  recognition  of  the  necessity  for  providing  for  those 
elements  of  deterioration  which  are  silently  accumulating  in  the 
present,  although  not  demanding  expenditures  until  some  time 
in  the  future.  While,  of  course,  it  is  impossible  to  keep  property 
at  100  per  cent,  condition  of  its  investment  value  when  taking 
into  account  theoretical  depreciation,  which  is  accruing  but  not 
accrued,  it  does  not  follow  that  value  for  rate-making  should 
be  based  on  anything  less  than  the  100  per  cent,  value.  To  re- 
quire a  utility  to  maintain  its  investment  at  practically  100  per 

'  In  re  Qui-fiiB  HorouKli  Gas  &  Electric  Co.,  11  P.  S.  C.  R.  544. 


DEPRECIATION  285 

cent,  value  would  mean  the  renewal  of  parts  long  before  they 
were  worn  out,  that  is,  a  deliberate  waste  of  material  and  equip- 
ment in  which  there  still  remains  large  service  value  simply  for 
the  purpose  of  permitting  the  investor  to  establish  a  basis  on 
which  to  earn  a  higher  rate  of  return. 

With  all  the  smaller  utilities  it  is  necessary  to  provide  a  depre- 
ciation reserve  fund  for  the  purpose  of  spreading  the  cost  of  final 
renewals  of  deteriorated  property  equally  over  the  life  of  such 
property.  While  this  setting  up  of  a  fund  results  temporarily 
in  decreasing  funds  available  for  dividends  to  stockholders,  never- 
theless, in  the  end  the  stockholders  receive  the  same  amount, 
because  if  the  fund  is  not  set  up,  all  earnings  being  paid  out  as 
dividends,  when  the  time  arrives  for  the  renewals  and  replace- 
ments, no  funds  being  in  hand,  their  cost  must  be  taken  from  net 
earnings  in  such  large  amounts  as  to  cause  a  temporary  deficit, 
or  certainly  the  material  reduction  or  entire  discontinuance  of 
dividends.  Moreover,  the  credit  of  a  company  is  much  better 
maintained  where  the  annual  operating  expenses  are  maintained 
nearly  uniform,  and  where  the  stockholders  receive  fairly  constant 
dividends.  Again,  the  public  will  better  understand  the  rela- 
tions between  the  public  and  the  stockholders  under  constantly 
maintained  conditions  than  in  cases  where  abnormally  large 
dividends  are  being  paid  a  portion  of  the  time,  and  no  dividends, 
or  proportionately  less  dividends,  are  being  paid  the  remainder 
of  the  time. 

Reserve  Funds. — Where  property  is  in  first-class  operating 
condition,  authorities  both  technical  and  legal  generally  agree 
that,  in  order  to  ascertain  the  total  value  of  the  utility  just  and 
proper  to  be  used  as  a  basis  of  fixing  rates,  there  should  properly 
be  added  to  the  value  of  the  depreciated  property  the  amount  of 
reserve  fund  on  hand,  in  cash  or  in  property,  if  that  fund  has  not 
already  been  included  as  a  part  of  the  property  being  appraised. 
It  is  only  in  case  the  reserve  depreciation  fund  does  not  equal 
the  amount  of  estimated  depreciation  or  where  a  fund  is  not  avail- 
able in  cash  or  property  that  some  authorities  claim  depreciated 
present  value  should  be  used  as  a  basis  of  rates.  The  difference 
of  opinion,  therefore,  between  those  who  deduct  from  reproduc- 
tion cost  new  the  amount  of  computed  or  accruing  depreciation 
and  those  who  make  no  deduction  in  determining  the  value 
for  fixing  rates  is  as  to  the  amount  of  the  depreciation  fund  and 
whether  or  not  it  is  what  may  be  termed  a  "liquid  asset."     It  is 


28G  VALUE  FOR  RATE-MAKING 

somewhat  difficult  to  understand  exactly  why  this  difference  in 
method  and  principle  should  be  adopted  simply  because  a  cor- 
poration may  or  may  not  have  "liquid  assets."  If  a  corporation 
has  good  credit  it  does  not  need  quick  assets  because  cash  can  be 
quickly  raised  in  case  of  emergency,  and  it  is  therefore  unneces- 
sary to  keep  a  part  of  its  assets  "liquid." 

It  is  frequently  argued  that  if  proper  depreciation  reserve 
funds  have  been  accumulated  by  a  corporation,  the  amount  of 
such  fund  added  to  the  present  depreciation  value  of  the  property 
would  equal  the  cost  of  reproduction  new. 

As  a  matter  of  fact,  the  reserve  funds  maintained  y>y  a  company 
have  nothing  whatever  to  do  with  the  value  of  the  property  on 
which  rates  should  be  based.  Reserve  funds  are  maintained 
for  various  purposes,  and  it  is  due  to  failure  to  distinguish  be- 
tween the  several  classes  of  reserve  funds  and  their  purpose, 
together  with  lack  of  appreciation  of  the  meaning  of  deprecia- 
tion, that  is  the  cause  of  the  illogical  attitude  of  many  minds  on 
this  subject. 

Reserves  are  set  up  or  accumulated  for  the  following  purposes : 

(a)  To  provide  a  "surge  tank"  which  will  serve  to  equalize 
the  fluctuation  in  expenditures  necessary  to  maintain  the  property 
in  first-class  operating  condition.  The  fund  is  provided  for  the 
purpose  of  evenly  distributing  the  cost  of  final  renewals  of  the 
various  parts  of  the  property,  over  the  space  of  time  assumed 
to  cover  the  period  of  life  during  which  the  several  parts  are  ex- 
pected to  render  effective  service.  This  uniformity  is  obtained 
by  annually  charging  against  revenue  and  as  a  part  of  operating 
expense  a  fixed  amount,  for  each  class  of  property,  determined 
from  a  consideration  of  its  value  and  assumed  normal  life,  in- 
cluding such  additional  allowance  as  is  necessary  to  cover  func- 
tional depreciation,  thereby  making  possible  the  maintenance 
of  constant  rates  for  service  and  fixed  dividends.  If  all  parts 
of  the  property  were  short  lived,  terminating  within  a  few  months 
after  installation,  every  utility  property  after  the  first  few  years 
would  have  practically  a  uniform  expenditure  for  renewals  and 
repairs,  and  in  that  case  would  require  no  reserve  account  to 
act  as  a  "surge  tank."  It  will  be  seen,  however,  that,  as  is  the 
fact  with  all  utilities  except  the  largest,  certain  parts  of  the  plant 
cost  relatively  large;  amounts  of  money  with  lives  extending  over 
a  period  of  years,  making  it  necessary  to  lay  aside  annually  a 
flefiiiite  sum,  which  yearly  sums,  with  or  without   the   interest 


DEPRECIATION  287 

accruing  thereon,  together  with  the  sum  obtained  by  the  sale  of 
scrap,  will  aggregate  an  amount,  at  the  end  of  the  life  of  the  prop- 
erty, equal  to  its  original  value,  in  order  to  permit  its  replacement 
without  the  issuance  of  new  capital  by  the  corporation  and  without 
unduly  increasing  operating  expenses  for  the  year  in  question, 
thereby  either  necessitating  temporarily  high  rates  or  compelling 
the  investors  to  go  without  dividends.  Depreciation  funds  of 
this  "surge  tank"  character,  provided  by  payments  of  the  con- 
sumer for  the  service  rendered,  do  not  return  to  the  investor 
any  of  the  capital  originally  put  into  the  enterprise  by  him ;  they 
simply  maintain  his  investment  and  keep  it  intact,  as  all  interest 
on  such  reserve  funds  is,  or  should  be,  applied  to  and  made  a 
part  of  the  fund  itself,  thus  helping  to  increase  the  fund,  and  to 
that  extent  reducing  the  amount  that  must  be  paid  in  by  the 
consumer.  It  will  be  recognized  that  the  reserve  funds,  of  the 
character  herein  being  discussed,  have  nothing  whatever  to  do 
with  fixing  the  value  of  the  property  upon  which  owners  are 
entitled  to  a  return.  A  reduction  of  the  original  investment  or  the 
cost  of  reproduction  new,  or  by  the  theoretical  amount  that  may 
be  estimated  should,  be  on  hand  or  accumulated  in  the  renewal 
or  "surge  tank"  reserve  fund,  is  confiscation  of  a  part  of  the 
property,  as  well  as  a  permit  to  the  consumer  to  contribute  for 
the  requirements  of  renewals  an  amount  less  than  that  actually 
necessary  because  calculated  on  a  partial,  instead  of  the  full,  value 
of  the  property  being  used.  Authorities  have  been  misled,  in 
considering  the  subject  of  depreciation,  by  assuming  that  the 
amount  paid  by  the  customers  for  the  accumulation  of  a  deprecia- 
tion fund  were  payments  made  as  a  return  to  the  owner  of  a  part 
of  his  investment,  instead  of  realizing  that  such  payments  were 
made  for  the  purpose  of  equalizing  maintenance  and  must  be 
imposed  in  addition  to  payments  for  normal  wear  and  tear. 
The  total  of  all  these  payments,  being  simply  to  provide  for  the 
different  classes  of  depreciation,  are  used  solely  to  maintain  and 
protect  the  property,  without  in  any  way  reimbursing  the  in- 
vestor. Where  sinking  fund,  improperly  called  depreciation 
fund,  accumulations  are  used  to  pay  off  capital  investments,  the 
difference,  that  is,  the  remainder  only,  after  deducting  the  pay- 
ment made  from  the  original  investment,  should  be  used  in  fixing 
rates,  but  where  funds  are  accrued  merely  as  a  "surge  tank,"  to 
take  care  of  renewals,  both  the  fund  must  be  accumulated  and  the 
fair  return  paid  on  the  investment  out  of  contributions  by  the 


288  VALUE  FOR  RATE-MAKING 

consumer.  It  would  be  illogical  and  unfair  to  claim  the  investor 
was  not  entitled  both  to  a  fair  return  upon  his  property  and  also 
necessary  funds  for  its  maintenance  in  100  per  cent,  condition, 
the  same  as  he  is  entitled  to  other  operating  expenses  and  taxes. 
It  is  difficult  to  see  how  such  elementary  principles  have  been 
disregarded,  even  by  some  who  are  assumed  to  have  knowledge 
and  experience  in  these  matters.  The  California  Railroad  Com- 
mission in  the  Palo  Alto  Gas  Company  case  said: 

"the  company  cannot  consistently  work  for  a  return  on  its  property 
as  if  it  were  new,  and  also  exiiect  to  set  aside  a  depreciation  fund." 

Why  the  company  in  that  case  should  not  expect  a  return  on  its 
investment  and  also  the  setting  aside  of  a  sufficient  fund  to  be 
ultimately  drawn  upon  in  maintaining  its  property  and  protect- 
ing its  investment,  is  difficult  to  see. 

During  the  entire  period  that  utility  property  is  rendering 
service  to  the  public,  the  owner  is  entitled  to  a  fair  return  upon 
its  full  value,  which,  upon  the  start,  would  be  universally  recog- 
nized to  be  the  amount  of  investment  fairly  and  judiciously  made. 
It  is  the  part  of  the  individuals  receiving  the  service  rendered  by 
this  property,  that  is,  the  consumers,  to  pay  to  the  owner  what- 
ever amount  may  be  necessary  to  maintain  the  property  and 
keep  the  investment  intact.  The  purpose  of  a  depreciation  fund 
is  to  maintain  the  integrity  of  the  plant  and  the  investment. 
Annual  payments  by  the  consumer  to  cover  wear  and  tear,  re- 
pairs and  renewals  do  not  go  either  as  dividends  or  return  of 
investment  to  the  stockholder,  but  have  their  own  province, 
namely,  to  maintain  the  property.  At  no  time  during  the  life 
of  the  property  under  normal  conditions  can  there  be,  nor  can 
there  properly  be  alleged  to  be,  any  impairment  of  the  value  of  the 
owners'  investment.  The  customer  is  responsible  for  the  annual 
accruing  liability  on  account  of  all  classes  of  depreciation  of  the 
plant,  and  it  is  customary  to  require  this  liability  to  be  paid  by 
the  consumer,  in  equal  amounts  regularly,  as  bills  for  service  are 
rendered.  After  the  payment  of  such  obligation,  the  consumer 
has  no  further  interest  in  the  property,  as  long  as  the  quality 
of  the  service  is  maintained.  Therefore,  the  application  of  the 
amoimts  paid  the  owner  for  renewals  cannot  in  any  way  affect 
the  value  of  the  property  continuing  to  render  the  service  desired, 
provided  always  the  property  is  maintained  in  condition  to  give 
first-class  service.     Whether  the  payments  to  the  owner  by  the 


DEPRECIATION  289 

consumer,  on  account  of  renewals,  have  been  deposited  in  a  reserve 
fund  or  not,  makes  no  difference  whatever  in  the  value  upon 
which  the  customer  must  pay  a  return,  because  the  owner  is, 
after  payments  have  been  made  by  the  consumer,  liable  for  the 
replacements,  which  liability  is  not  affected  by  the  existence 
of  a  reserve  fund.  The  deduction  of  any  amount  equivalent 
to  an  estimated  fund,  from  original  or  reproduction  cost  in  de- 
termining the  basis  for  earnings  or  rates,  is  purely  arbitrary  and 
without  justification  in  logic,  economics  or  engineering. 

(b)  Public  utilities  are  operating  either  under  a  limited  or  an 
"indeterminate"  or  unlimited,  franchise.  Where  the  franchise 
is  unlimited  as  to  duration,  it  may  generally  be  assumed  that  the 
utility  will  continue  the  use  of  its  property  in  the  service  of  the 
public  indefinitely.  Under  such  conditions  there  exists  no 
necessity  for  the  accumulation  of  a  sinking  fund  sometimes  called 
a  "depreciation  fund,"  or  "reserve  fund,"  to  pay  back  to  the 
investor  the  value  of  his  property.  On  the  other  hand,  where 
a  franchise  is  limited  to  a  definite  term  of  years,  or  where  for  other 
reasons  the  life  of  the  utility  is  fixed,  it  is  necessary  during  the 
period  of  its  existence  for  the  utility  to  accumulate  a  separate 
and  distinct  fund,  that  at  the  time  necessary  to  reimburse  the 
investor  the  amount  of  the  fund,  together  with  the  cash  re- 
ceived from  the  sale  of  scrap  or  salvage,  will  equal  the  value  of 
the  property.  This  fund  must  be  accumulated  from  year  to  year 
by  payments  made  by  the  consumer  for  the  service  he  is  receiv- 
ing, and  has  nothing  to  do  with  depreciation,  renewal,  or  "surge 
tank"  funds,  previously  discussed,  the  sum  of  all  of  which  must 
be  included  as  part  of  the  cost  of  said  service.  In  some  cases  it 
may  not  be  necessary  that  an  actual  sinking,  or  reserve,  fund  be 
accumulated.  In  practice  it  may  be  possible  at  the  end  of  each 
year  to  immediately  pay  back  to  the  investors  the  amount  of 
capital  paid  in  by  the  consumer  for  that  particular  year;  this 
may  be  done,  for  example,  by  using  the  amounts  collected  from 
the  consumer  in  paying  off  bonds,  called  by  allotment,  or  any 
other  indebtedness  of  the  company,  but  it  is  not  always  possible 
to  work  the  matter  out  in  this  way,  because  of  the  relatively  small 
amounts  paid  annually,  which  on  this  account  are  unacceptable 
to  the  investor. 

Similarly,  if  instead  of  making  annual  payments  to  the  in- 
vestors on  account  of  principle,  the  contributions  of  the  consumer 
are  allowed   to  accumulate  in  a   reserve  fund,  which   may  be 

19 


290  VALUE  FOR  RATE-MAKING 

invested,  provided  the  investment  is  a  "liquid  asset"  available 
for  promptly  paying  the  investor  in  the  corporation  when  the 
payment  becomes  due,  the  earnings  of  the  reserve  may  be  either 
added  to  the  reserve  thereby  the  more  rapidly  effecting  its 
accumulation,  or  the  earnings  may  be  paid  to  the  owner  direct, 
thereby  reducing  by  that  amount  the  return  that  may  be  ex- 
actetl  from  the  consumer  in  paying  for  the  service  rendered. 

It  will  be  of  course  recognized  that  in  all  such  cases  as  these 
now  mentioned,  where  the  corporation  can  pay  l)ack  to  its  owners 
certain  portions  of  their  investment,  year  by  year,  and  the  latter 
thereby  get  part  of  their  original  investment  out  of  the  property, 
the  amount  of  such  payments  on  account  of  principle  must  be 
deducted  from  the  original  investment  or  the  present  I'cproduction 
value  new  of  the  utility,  in  determining  the  sum  upon  which  to 
fix  rates  or  the  proper  amount  upon  which  the  investor,  there- 
after, is  entitled  to  a  fair  return.  It  is  due  to  this  very  proper, 
although  perhaps  somewhat  exceptional  application  of  a  part  of 
revenue  and  the  payments,  by  the  consumer  to  the  owner,  of  the 
amounts  of  the  original  investment,  improperly  called  deprecia- 
tion, that  has  confused  the  lay  mind  and  resulted  in  a  demand  for 
deduction  of  all  reserve  funds,  or  theoretically  computed  de- 
preciation from  the  original  or  reproduction  value  of  the  property 
in  determining  present  value. 

(c)  All  utilities  are  liable  to  contingencies  and  must  provide 
for  the  unexpected.  In  order  to  carry  a  species  of  insurance, 
many  corporations  provide  a  contingency  reserve  fund  which  will 
amount  to  a  relatively  small  percentage  of  the  value  of  the 
property.  This  fund  is  nothing  more  than  a  "safety  valve" 
which,  under  normal  conditions,  is  maintained  at  a  uniform 
amount,  perhaps  requiring  no  accretions,  but  under  higher  pres- 
sure conditions  of  financial  stringency,  strikes,  fire,  earthquakes, 
or  other  similar  "acts  of  God"  the  fund  is  a  quick  asset  that  is 
drawn  upon  to  meet  the  emergency.  After  the  emergency,  the 
fund  must  be  replenished  either  by  payments  from  insurance 
companies  or  some  such  source,  or  by  contribution  from  revenue 
of  a  portion  of  the  payments  made  by  the  consumer  for  the  service 
rendered.  It  is  to  provide  this  contribution  that  small  allow- 
ances, say  1  per  cent,  of  gross  revenue,  are  frequently  made  in 
fixing  rates  to  be  paid  by  the  consumer.  Such  payments,  how- 
ever, being  used  simply  to  maintain  a  contingency  reserve,  do  not 
result  in  any  renunieration  to  the  original  investor  or  in  any  way 


DErHKCIATION  2'.»1 

decrease  the  value  of  the  property;  hence  the  contingency  fund 
cannot  properly  be  deducted  from  original  cost  or  reproduction 
new  in  determining  the  value  of  the  property  used  in  service  to 
the  public.  If  the  fund  has  been  accumulated  out  of  payments 
contributed  by  the  consumer,  after  commission  rule  was  inaugu- 
rated, the  owner  of  the  corporation  is  entitled  to  no  return  on 
the  fund.  On  the  other  hand,  if  the  fund  was  originally  estab- 
lished by  the  owner  either  by  cash  payment  as  an  original  invest- 
ment or  through  the  waiving  of  lights  to  a  certain  amount  of 
dividends,  thereby  permitting  the  gradual  accretion  of  such 
fund,  the  owner  is  entitled  to  a  return  on  the  amount  of  the  con- 
tingency fund,  and  it  should  be  included  with  the  value  of  the 
other  property  in  determining  the  total  fair  value  to  be  used  as 
a  basis  of  fair  return  or  in  fixing  rates. 

Depreciation  Funds. — The  usual  method  of  computing  and 
making  allowances  for  depreciation  and  depreciation  funds  are 
what  is  known  as  either  the  straight  line  or  sinking  fund  method. 
Both  methods  are  widely  used  and  each  has  its  ardent  exponents. 
The  straight  line  method  has  been  more  frequently  employed 
than  all  other  methods  for  the  following  reasons: 

First. — Because  the  lives  of  much  property  and  apparatus  is 
brief,  so  that  any  method  would  not  differ  much  in  the  final 
results. 

Second. — The  application  of  this  method  is  the  most  simple, 
direct  and  easily  understood,  hence  naturally  favored,  particularly 
by  utility  accountants  and  non-technical  men  who  constitute 
so  large  a  proportion  of  the  regulating  bodies  and  courts. 

Third. — "The  profit  earned  by  the  undertaking  year  by  year  is 
itself  the  full  interest  or  increment  accruing  to  the  capital  of  the  under- 
taking, and  it  is  as  unsound  to  forestall  and  apply  future  interest  (as 
is  involved  by  the  use  of  the  sinking  fund)  in  a  manner  which  operates 
to  retain  the  surviving  value  of  plant  in  the  books  at  too  large  a  sum, 
as  it  would  be  to  apply  interest  to  add  to  the  value  of  unsold  stock  or 
unpaid  debts  in  which  a  large  part  of  the  capital  of  industrial  undertak- 
ings is  locked  up,  and  for  this  reason  it  is  a  misuse  of  the  sinking  fund 
to  apply  it  as  the  measure  of  the  annual  depreciation  of  plant. "^ 

The  Public  Service  Commission  of  New  York,  First  District, 
has  always  used  the  straight  line  method  and  the  reasons  there- 
fore have  been  testified  to  by  Ex-Commissioner  Maltbie  as  follows : 

>  "The  Use  and  Misuse  of  the  Sinking  Fund,"  by  P.  D.  Le.ike. 


2')2  VALUE  FOR  RATE-MAKING 

"Q.  (By  Chairman  Hughes).  May  I  ask  you  why  you  prefer  the 
straight  line  depreciation  to  tlie  sinking  fund  plan?  A.  Whv  I  prefer 
it? 

Q.  Yes,  why  you  select  that,  considering  both  funds  would  be  in- 
vested, one  in  extensions  to  the  property  and  the  other  on  the  side, 
and  earning  an  interest?  A.  In  the  first  place,  ordinarily  that  is  the 
method  which  is  adopted  and  more  easily  understood  by  the  company's 
operating  public  utilities.  Secondly,  unless  great  care  is  taken  in  main- 
taining the  sinking  fund  and  credits  are  made  to  that  fund  of  the 
interest  as  compounded  year  by  year,  you  will  not  have  a  sufficient 
amount  when  replacements  become  due,  and  it  is  fundamental  that  it 
shall  be  followed  by  strict  mathematical  accuracy,  or  it  will  not  work  out 
properly. 

Q.  That  is  to  say  it  is  more  complicated  than  the  other?  A.  It  is 
more  complicated  than  the  other. 

Q.  Not  as  easily  handled?  A.  And  in  tlie  third  place,  if  retirements 
are  necessary  before  the  end  of  the  estimated  life,  or  if  repairs  occur  in 
the  earlier  years  for  part  of  a  group,  the  sinking  fund  method  will  not 
work  out  because  in  the  earlier  years  it  grows  very  slowly  and  then  in 
the  later  years  of  the  period,  grows  very  rapidlv;  consequently  a  little 
deficiency  in  the  earlier  years,  in  the  fund,  will  very  seriously  affect  the 
amount  which  will  be  found  in  the  fund  at  the  end  of  the  time."^ 

The  Railroad  Commission  of  Wisconsin  use  both  the  straight 
line  and  the  sinking  fund  method,  preferring  the  latter  except 
where  the  life  of  property  is  rather  short.  The  views  of  the 
Wisconsin  Commission  are  briefly  set  forth  in  the  following: 

"There  are  two  methods  in  common  use  among  public  utilities,  out- 
side of  steam  railways,  for  determining  depreciation.  One  of  these  is 
known  as  the  straight  line  method.  Under  it  the  hfe  of  the  unit  is 
determined,  and  it  is  then  assumed  that  during  this  life  the  depreciation 
is  uniform.  For  units  having  a  life  of  ten  years,  one-tenth  of  their  cost 
is  then  set  aside  annually  for  their  replacement.  When  of  these  ten 
years,  five  have  elapsed,  the  unit  is  supposed  to  be  worth  only  one-half 
of  its  original  cost,  or  of  the  cost  of  replacing  it.  This  method  is  com- 
paratively simple  and  has  been  widely  used. 

The  other  method  is  based  upon  a  slightly  different  theory.  In 
this  case  it  is  assumed  that  the  amount  set  aside  annually  for  deprecia- 
tion should  be  invested  at  compound  interest,  and  that  the  amount  so 
set  aside,  plus  the  interest,  will  be  sufficient  to  cover  the  replacement 
at  the  end  of  the  life  of  the  property.  Since  in  this  case  the  interest 
also  is  made  a  part  of  the  fund,  it  follows  that  the  amount  that  must  be 

'  Testimony  of  Hon.  Mil.  R.  Maltbie  before  Ohio  Public  Service  Commission  in  re  Bucy- 
ruB  LiKlit  A  Power  Co..  Jan.  and  Feb.,  1914. 


DEPRECIATION  293 

set  aside  each  year  is  smaller  than  it  would  be  if  interest  was  not  al- 
lowed or  included.  Under  this  method  the  value  of  the  unit  at  any 
intermediate  year  during  its  life  is  its  first  cost,  or  the  cost  of  repro- 
duction less  the  amount  of  the  sums  set  aside,  including  the  interest  on 
the  same. 

Under  the  first  of  these  plans  the  drop  in  value  is  the  same  each  year 
during  the  earlier  life  of  the  unit.  Under  the  second  method  the  drop 
is  light  at  first,  while  the  amount  set  aside  is  small,  but  it  increases  as 
this  amount  grows  large,  and  toward  the  end  of  the  period  it  rises  quite 
rapidly.  For  short  life  units  the  difference  between  the  two  methods  is 
probably  not  very  material.  For  long  life  units,  on  the  other  hand, 
the  difference  may  be  of  importance.  This  is  especially  true  when  there 
are  changes  n  the  ownership.  Since  under  the  latter  method  the  fall 
in  the  value  is  greater  in  the  latter  than  in  the  first  part  of  the  period, 
it  would  also  seem  that  depreciation  would  fall  heavier  on  purchasers 
than  on  sellers  of  such  plants."^ 

The  courts  have  rather  leaned  to  the  simpler,  more  direct 
straight  line  method  for  estimating  depreciation  allowance. 

"The  courts  below  determined  that  the  relator  was  entitled  to  make 
annual  depreciation  charges,  amounting  in  the  case  of  the  borough  of 
Manhattan  to  the  sum  of  $360,613.65  and  in  the  case  of  the  borough  of 
the  Bronx  to  the  sum  of  $37,435.67,  for  the  purpose  of  creating  a  fund 
to  provide  for  the  depreciation  of  its  various  properties;  upon  which 
interest  at  4  per  cent.,  compounded,  would  produce  a  sum,  at  the  ter- 
mination of  the  ascertained  physical  life  of  the  several  classes  of  property 
equal  to  the  cost  of  the  particular  property.  While  I  am,  personally,  of 
the  opinion  that  the  creation  of  such  an  amortization  fund  furnishes 
the  best  rule  for  adoption  in  such  a  case  as  this,  in  working  out  the 
value  of  special  franchises,  the  majority  of  my  brethern  entertain  a 
different  view.  They  think  that  the  annual  allowance  for  depreciation 
should  be  computed  by  dividing  the  values  of  the  various  kinds  of  tan- 
gible property  by  the  number  of  years  of  their  respective  estimated 
physical  lives  and  that  will  be  the  opinion  of  the  court." 

"The  special  term  in  this  case,  however,  adopted  a  plan  of  amortiza- 
tion upon  which  an  annual  sum  was  authorized  to  be  set  apart  as  a 
sinking  fund,  which,  by  compounding  the  interest  thereon  for  a  period 
equal  to  the  life  of  the  structure,  tracks,  engines,  machinery  and  rolling 
stock,  would  at  the  end  of  chat  period  create  a  fund  sufficient  to  replace 
the  property.  The  difficulty  with  such  holding  is  that  railroad  cor- 
porations do  not  reconstruct  their  railroads  and  rolling  stock  in  that 
way.  In  order  to  afford  proper  protection  to  the  public  they  are  re- 
quired to  maintain  a  high  state  of  efficiency  both  in  roadbed  and 

1  Hill  et  al.  vs.  Antigo  Water  Co.,  3  W.  R.  C.  R.  643. 


294  VALUE  FOR  RATE-MA KIXC 

rolling  stock.  Tlie  relator's  railroad  has  been  in  existence  already  for 
about  30  years  and  some  portion  of  its  propertj^  has  already  suffered 
from  decay  and  use  to  such  an  extent  that  portions  thereof  have  to  be 
reconstructed  and  made  new  each  year.  Old  ties  have  to  be  removed 
and  replaced  with  new  ones;  old  rails  that  have  become  worn  and 
battered  have  to  be  removed  and  their  places  supplied  with  new  rails 
and  so  the  work  of  reconstruction  progresses  from  year  to  year.  It  is 
not  the  waiting  40  or  60  years  to  reconstruct,  during  which  time  the 
amount  set  apart  as  a  sinking  fund  may  be  doubled  many  times  over 
by  compounding  the  interest,  but  it  is  the  annual  expenditure  for  re- 
construction which  is  to  be  paid  for  at  the  time  that  the  construction  is 
made.  To  illustrate:  Suppose  the  average  life  of  the  tangible  property 
of  a  railroad,  outside  of  the  land  itself,  to  l^e  60  years  and  the  cost  of 
reconstruction  to  be  $60,000,000,  it  would  follow  that  $1,000,000  would 
have  to  be  used  each  year  in  reconstruction,  and  that  amount  would 
have  to  be  annually  used  for  that  purpose ;  l)ut  under  the  plan  adopted 
in  this  case,  instead  of  deducting  from  the  gross  earnings  the  amount 
necessarily  expended  for  that  purpose,  a  small  fraction  of  that  sum, 
viz.,  $4,200  only  is  allowed  to  be  deducted,  a  sum  which,  with  the 
interest  compounded  for  the  next  60  years,  would  amount  to  $1,000,000. 
Under  such  a  plan  the  company  would  be  practically  prohibited  from 
annually  constructing  a  portion  of  its  road  and  thus  prevented  from 
keeping  it  in  that  state  of  efficiency  which  the  public  demands.  Of 
course  tlie  necessities  of  reconstruction  vary  from  year  to  year;  some 
years  it  may  be  greater  than  others,  but  the  assessors  each  year  can  easily 
ascertain  the  sum  required  for  that  purpose.  I  think,  therefore,  that  we 
should  adhere  to  the  rule  sanctioned  in  the  Jamaica  case,  and  that  a  gross 
sum  should  be  deducted  annually  for  the  purposes  of  reconstruction."' 
"Of  course  our  estimate  could  not  be  based  upon  the  proposition 
that  the  per  centum  set  apart  to  cover  depreciation  would  be  deposited 
in  bank  or  loaned  out  from  year  to  year  so  as  to  accumulate  and  be  on 
hand  at  the  end  of  14  years,  and  to  be  then  u.sed  to  construct  an  en- 
tirely new  plant,  and  so  on  from  period  to  period.  In  such  a  case  the 
public  would  not  only  have  a  service  that  would  progressively  grow 
worse  until  its  operations  ceased  altogether,  l)ut  it  would  thereafter 
get  no  service  at  all  until  a  new  plant  replacing  the  old  could  be  com- 
pleted and  put  into  operation.  The  question  rather  has  been.  What 
does  experience  show  to  be  the  proper  average  per  cent,  of  annual 
earnings  which  the  company  should  expend  in  order  to  insure  that  its 
plant  at  the  end  of  14  years  will  be  as  good  as  it  now  is,  and  in  the 
meantime  render  to  the  public  that  good  service  which  its  duty  to  the 
puljlic  requires?"'-' 

'  People  ex  rel.  .Manhattan  Railway  Company  vs.  Woodbury,  203  N.  Y.  231,  Oct.  17,  1911. 
*  Cumberland  Telephone  and   Telegraph   Co.  vs.  City  of  Louisville,  187   Fed.  637,  Apr. 
2.1.  KMl. 


DEPRFJIA  TION  295 

The  Pul)li('  ITtillties  Act  of  the  State  of  Cahfornia,  Sectioii 
49,  reads: 

"The  Commission  shall  have  power,  after  hearing,  to  require  any  or 
all  public  utilities  to  carry  a  proper  and  adequate  depreciation  account 
in  accordance  with  such  rules,  regulations  and  forms  of  account  as  the 
Commission  may  prescribe.  The  Commission  may,  from  time  to  time, 
ascertain  and  determine  and  by  order  fix  the  proper  and  adequate  rates 
of  depreciation  of  the  several  classes  of  property  of  each  public  utility. 
Each  public  utility  shall  conform  its  depreciation  accounts  to  the  rates 
so  ascertained,  determined  and  fixed,  and  shall  set  aside  the  moneys 
so  provided  for  out  of  earnings  and  carry  the  same  in  a  depreciation  fund 
and  expend  such  fund  onlj^  for  such  purposes  and  under  such  rules  and 
regulations,  both  as  to  original  expenditure  and  subsequent  replace- 
ment as  the  Commission  may  prescribe.  The  income  from  investments 
of  moneys  in  such  fund  shall  likewise  be  carried  in  such  fund." 

Commenting  on  this  requirement  of  the  California  law  and  the 
necessity  of  preserving  payments,  made  on  account  of  deprecia- 
tion, in  a  fund  to  be  held  sacred  to  provide  renewals  and  replace- 
ments, Commissioner  Thelen  says: 

"I  desire  to  draw  particular  attention  to  the  last  sentence,  under 
which  the  income  from  the  investment  of  moneys  in  public  utilitj^  de- 
preciation funds  in  this  State  must  be  carried  in  the  depreciation  fund 
itself.  In  other  words,  the  interest  earned  by  moneys  in  the  deprecia- 
tion fund  cannot  be  used  for  the  payment  of  dividends  or  f(jr  meeting 
operating  expenses.  This  fund,  together  with  the  interest  on  all 
moneys  invested  therein,  is  a  trust  fund  set  aside  for  the  specific  purpose 
of  taking  care  of  replacements,  whether  of  worn  out  material  or  of 
material  which  has  become  obsolescent  or  inadequate,  in  accordance 
with  such  rules,  regulations  and  forms  of  account  as  this  Commission 
may  prescribe.  As  the  interest  is  to  remain  a  portion  of  the  fund,  it 
would  seem  that  ordinarily  in  this  State  the  sinking  fund  basis  should 
be  used  in  determining  the  amount  to  be  set  aside  annually  in  this 
fund."i 

"During  the  term  of  life  of  the  property  the  company  gets  no  benefits 
of  the  annual  payment  made  by  the  public.  The  interest  accretions  are 
added  to  the  principal,  and  at  the  end  of  the  estimated  term  the  company 
simply  has  enough  money  to  replace  the  property.  During  the  entire 
period  the  company  has  the  same  amount  invested  or  used  in  the 

'  Decision  of  the  Railroad  Commission  of  California,  Town  of  Antioch  vs.  Paoific  C!as  and 
Electric  Company,  Case  No.  400;  Decision  No.  1655,  July  0,  1914. 


29r)  VALVE  FOR  RATE-MAKING 

public  service,   and  therefore  during  the  entire  assumed  life  of  the 
property  is  entitled  to  the  same  amount  of  annual  return  thereon."^ 

Mr.  P.  D.  Leake,  of  London,  an  authority  in  accounting  says, 
regarding  sinking  fund  methods: 

"I  have  noticed  that  these  devices  have  an  extraordinary  attraction 
for  many  types  of  mind,  and  that  too  often  the  results  expected  are  not 
attained.  May  I  impress  upon  you  that  these  devices  are  dangerous 
expedients  in  any  but  the  most  skilful  hands.  In  practice,  then,  the 
sinking  fund  is  merely  a  convenient  method  of  accumulating  a  certain 
sum  of  money  by  a  given  date  by  means  of  annually  investing  a  fixed 
sum  of  money  in  the  meantime.  It  is  apt  to  give  a  sense  of  false  security, 
because  its  whole  virtue  depends  upon  its  obligations  being  faithfully 
carried  out  over  the  whole  period,  and  this  condition  is  not  always 
fulfilled.  The  reason  is  that  the  sinking  fund  discounts  the  future, 
and  depends  upon  the  performance  of  acts  in  the  future,  sometimes 
over  a  very  long  period,  and  no  one  can  tell  how  in  the  meantime 
circumstances  may  alter  and  conditions  change.  It  is  probable  that 
in  many  cases  the  use  of  a  sinking  fund  is  an  altogether  unwarrantable 
draft  drawn  upon  the  future,  because  there  is  no  reasonable  certainty 
that  the  fund,  whether  it  be  State,  municipal,  or  commercial,  will  not 
be  raided  before  it  attains  its  object."^ 

Tiio  depreciation  reserve  fund  is  simply  used  to  equalize  pay- 
ments over  a  long  period  of  time,  the  same  way  that  a  flywheel 
absorbs  and  delivers  energy  at  alternate  intervals. 

Where  depreciation  funds  have  been  accumulated,  the  amount 
of  such  funds  should  be  added  to  the  depreciated  value  of  the 
property — if  such  value  instead  of  cost  of  reproduction  new  is 
used — in  determining  the  amount  upon  which  fair  returns  are  to 
be  allowed.  This  is  the  regular  procedure  followed  by  many 
public  authorities  and  has  been  the  practice  of  the  Railroad  Com- 
mission of  Wisconsin  for  years: 

"As  under  normal  conditions  investors  are  entitled  to  have  their 
property  or  investment  kept  intact,  it  follows  that  the  amounts,  which 
have  been  properly  set  aside  for  such  purposes,  or  for  depreciation,  in 
accordance  with  the  provisions  of  the  law  and  the  rules  of  the  Commis- 
sion, should  in  the  instant  case  be  included  in  the  amount  upon  which 
returns  are  allowed.     On  the  other  hand,  amounts  earned  for  deprecia- 

•  Public  Service  Commission,  State  of  New  York,  Second  District,  Louis  P.  Fulirmann 
VB.  The  Cataract  Power  &  Conduit  Company,  decided  Apr.  2,  1913,  P.  S.  C.  R.,  2d  Dist., 
Vol.   III.  page  717. 

The  Use  and  Misuse  of  the  Sinking  Fund." 


DEPRECIA  TION  297 

tion  but  withdrawn  or  used  for  other  purposes  than  jjrovided  by  law 
shouhi  not  be  so  inchided."' 

Value  not  Fixed  by  Depreciation  Fund. — Where  a  corporation 
is  created  under  conditions  prescribed  in  advance  by  regulating 
bodies,  or  where  rates  include  such  allowance,  there  can  be  no 
objection  to  the  insistence  upon  the  accumulation  of  deprecia- 
tion funds  out  of  revenue,  but  then  such  funds  cannot  necessarily 
be  used  as  a  measure  of  value  of  the  property  upon  which 
rates  are  to  be  fixed,  without  regard  to  maintenance  and  con- 
dition, even  if  original  investment  and  not  present  value  is 
to  be  taken  for  all  time  as  the  basis  of  fixing  rates.  It  will  be 
seen  that  the  attempt  to  determine  present  depreciated  value  by 
deducting  from  reproduction  cost  the  amount  of  the  accumulated 
reserve  fund — assumed  to  have  been  accumulating  from  the 
origin  of  the  corporation — results  in  an  absurdity,  because  the 
fund  is  based  upon  an  estimate  related  to  the  original  investment. 
If  the  cost  of  reproduction  new  determined  from  a  consideration 
of  present  values  is  first  obtained  and  the  amount  of  the  accumu- 
lated reserve  fund  then  deducted,  the  present  depreciated  value 
will  be  found  excessively  large,  in  the  case  of  a  corporation,  the 
property  of  which  has  enormously  increased  in  value,  and  the 
deduction  of  the  same  reserve  fund  from  the  cost  of  reproduction 
new  of  property  that  has  largely  decreased  in  value  will  give 
a  present  depreciated  value  entirely  too  small.  So  that  even  in 
the  case  of  a  corporation  originated  under  public  service  rules 
and  regulations  and  adhering  thereto  throughout  its  existence, 
cannot  have  its  property  value  determined  at  any  time  in  the 
future  merely  by  deducting  from  the  cost  the  amount  of  the 
accrued  depreciation  fund. 

To  further  analyze  the  theory  that  present  value  should  be 
determined  by  deducting  from  the  investment  or  reproduction 
value  the  amount  of  a  depreciation  fund  in  hand,  it  must  be  re- 
membered that  the  rate  at  which  the  fund  is  accumulated  is  an 
average  one,  and  may  be  excessive  or  less  than  the  requirements. 
If  a  newly  organized  corporation  operating  under  commission 
rule  begins  accumulating  a  fund  on  the  basis  of  generally  ac- 
cepted rates  of  depreciation,  it  might  be  easily  possible  that 
through  some  rather  special  circumstances,  or  contingency, 
a  larger  than  normal  amount  was  required  to  be  withdrawn  from 
the  fund  to  provide  for  renewals  necessary;  therefore,  the  fund 

»  Superior  Commercial  Club  et  al.  vs.  Duluth  Street  Railway  Co.,  11  W.  R.  C.  R.  21. 


298  VALUE  FOR  RATE-MAKING 

being  largely  depleted  or  perhaps  entirely  wiped  out,  the  present 
value  of  the  property,  on  the  theory  being  considered,  is  reduced 
by  the  amount  of  the  computed  but  lacking  fund,  necessarily 
expended;  consequently  the  owners,  through  no  fault  of  their 
own,  simply  because  they  have  well  maintained  the  property, 
are  thereby  deprived  of  a  portion  of  the  return  due  them  on 
which  they  would  receive  under  normal  conditions. 

In  any  case,  if  theoretical  depreciation  were  to  be  considered, 
in  determining  present  value,  there  is  no  logic  or  reason  for 
figuring  depreciation  on  all  of  the  property  in  determining  the 
amount  to  be  deducted  from  investment  or  rejn'otluction  value. 
A  large  proportion  of  the  values  included  in  every  appraisal  does 
not  depreciate  and  therefore,  such  non-depreciable  parts  should 
not  })e  reduced  by  an  estimated  amount  of  depreciation  which  is 
applicable  to  other  depreciable  parts  of  the  property. 

"Now  it  seems  tliat  about  half  or  more  of  the  overhead  is  permanent, 
does  not  depreciate,  and  therefore,  will  not  be  required  in  reconstruc- 
tion. For  instance,  it  is  held  that  only  in  total  supersession  do  all  over- 
head charges  depreciate  and  that  a  normal  depreciation  allowance 
should  not  be  l)ased  upon  such  assumption.  It  is  held  that  certain 
charged  for  engineering  and  supervision  do  not  depreciate  and  that  cost 
of  contingencies  and  losses  during  construction  do  not  necessarily 
have  to  be  replaced  in  their  entirety.  Also,  that  interest  during  con- 
struction is  in  the  same  category,  while  preliminary  organization,  pro- 
motion, development,  administration  and  legal  expenses  do  not  usually 
have  to  be  repeated  in  replacement."^ 

The  argument  that  the  allowance  of  appreciation  in  real 
estate  values  logically  includes  a  deduction  for  depreciation,  does 
not  follow.  Increase  in  capital  account,  which  is  the  result  of 
appreciation  of  land  values  is  not  in  any  way  related  to  revenue 
and  operating  expenses,  to  which  alone  is  depreciation  chargeable. 

Under  the  Interstate  Commerce  regulations,  as  well  as  those 
promulgated  bj^  most  of  the  State  connnissions,  and  in  accord- 
ance with  the  practice  of  wcll-iun  corpoi'ations  iccjuirements  to 
meet  both  current  and  deferred  maintenance  are  included  as  a 
part  of  the  oi)erating expense,  to  be  deducted  from  revenue,  before 
the  payment  of  dividends.  It  makes  little  difference  whether  the 
allowance  above  that  required  for  wear  and  tear  is  accunuilated 
in  a  reserve  fund  or  credited  to  the  profit  and  loss  account,  in 

'  Decision  of  tlio  WiHoonsiii  Hailroad  Commission  tialcd  Nov.  2'i,  1913,  Milwaukee 
KIcctric  Uuilwuy  and  Light  Company.  13  W.  11.  C.  1{.  22S. 


DEPRECIA  TIOX  290 

either  case  it  may  be  available  for  taking  care  of  renewals  when 
they  have  accrued.  As  charges  on  account  and  wear  and  tear  or 
renewals  can  be  made  only  from  revenue,  there  is  no  reason 
why  it  should  be  confused  with  the  capital  account  or  deducted 
from  investment  in  determining  value  for  rates.  Failure  to 
provide  depreciation  rests  with  the  owner  who  must  make  good 
any  deficiencies  which  may  result  from  payment  of  dividends  or 
other  diversions  of  revenue,  if  earned,  and  in  many  cases,  in 
order  to  protect  his  investment,  even  if  not  earned. 

Any  attempt  to  reduce  rates  by  using  present  depreciated, 
instead  of  reproduction  new  values,  is  nullified,  because,  logically, 
as  much  higher  rate  of  depreciation  must  be  provided  in  the  rate 
as  the  total  value  of  the  property  is  reduced.  That  is,  if  5  per 
cent,  is  the  proper  rate  to  allow  for  providing  for  depreciation 
on  the  basis  of  reproduction  cost,  then,  if  the  value  of  the  property 
should  be  depreciated  down  to  one-half  reproduction  cost,  it 
follows  that  the  rate  of  depreciation  should  be  10  per  cent.,  mak- 
ing the  charge  to  the  consumer  the  same  in  either  case,  in  order 
that  funds  may  be  on  hand  to  renew  the  property  at  the  expira- 
tion of  its  life.  In  the  same  way,  the  rate  of  return  allowed  the 
owner  should  be  doubled  if  the  theoretically  depreciated  value  of 
the  property  is  taken  at  half  the  reproduction  value. 

Moreover,  there  are  few  corporations  which  from  the  be- 
ginning can  do  business  and  charge  rates  sufficiently  high  to 
permit  earnings  large  enough  to  provide  for  a  depreciation  re- 
serve fund.  Such  being  the  fact  with  regard  to  newly  originated 
corporations  starting  under  public  regulation  rules,  how  much 
more  it  is  evident  that  the  value  of  property  of  long  existing 
corporations  which  were  required  neither  by  public  authorities 
or  their  own  directors  or  stockholders  to  accumulate  large  funds 
can  now  have  the  value  of  their  property  determined  by  de- 
ducting from  cost  of  reproduction  new  the  amount  of  a  theo- 
retical reserve  fund  which  will  vary  in  amount  depending  on  the 
method  used  in  computation,  and  for  which,  at  least  in  any 
large  amounts,  many  authorities  agree,  there  exists  no  necessity. 
In  the  second  place,  it  may  be  seriously  questioned  whether  there 
exists  necessity  for  the  accumulation  of  anything  greater  than  a 
contingency  reserve  fund,  except  in  the  case  of  a  limited  fran- 
chise or  where  the  life  of  a  utility  is  definitely  determined;  in 
such  instances  there  must  be  accumulated  funds  sufficiently 
large  to  ultimately  return  to  the  investor  the  full  value  of  his 


300  VALUE  FOR  RATE-MAKING 

property.  In  exceptional  cases  there  may  be  required  no  depre- 
ciation reserve  funds  whatsoever.  A  corporation  that  has  its 
property  widely  distributed,  of  various  characters  with  single  units 
of  relatively  small  value  may  not  require  any  reserve,  because, 
the  deterioration  of  property — after  the  first  few  years  of  opera- 
tion— is  taking  place  at  an  approximately  uniform  rate  per  annum 
and  therefore,  all  depreciation  becomes  wear  and  tear,  and  is 
taken  care  of  as  a  part  of  the  annual  operating  expense;  as  an 
example,  the  Third  Avenue  Street  Railway  Company,  of  New 
York  Cit}',  may  be  cited.  This  property  consists  of  nearly  300 
miles  of  surface  track,  partly  overhead  and  partly  underground 
trolley,  with  rolling  stock  to  correspond  of  all  sizes  and  types, 
as  well  as  storage  battery  cars,  underground  conduits,  cables, 
overhead  transmission  systems,  car  barns,  substations,  generat- 
ing station,  real  estate,  and  other  property  extending  from 
the  lower  end  of  the  Island  of  Manhattan  up  to  and  through  the 
Bronx  and  the  County  of  Westchester,  so  that  the  exhaustion  of 
any  physical  property,  as  far  as  can  be  anticipated,  will  not 
result  in  unduly  increasing  operating  expenses  for  its  replace- 
ment, or  affecting  net  income,  or  in  any  way  jeopardizing  service 
or  charges  to  the  public.  Why  then  should  this  corporation  be 
compelled  to  have  on  hand  a  reserve  fund  equal  to  the  difference 
between  cost  of  reproduction  new  and  its  theoretical  depreciated 
present  value,  that  is,  a  fund  equal  to  15  per  cent.,  or  20  per  cent., 
of  the  total  value,  namely,  a  fund  of  from  $9,000,000  to  $15,000,- 
000  for  which  the  corporation  has  no  use,  except  to  be  allowed 
to  earn  a  fair  return  on  the  full  value  of  its  property'  and  from 
which  the  public  will  gain  no  advantage,  because  under  public 
regulation  the  corporation  is  compelled  to  render  adequate  and 
reasonable  service.  Commission  regulation  always  provides  for 
proper  maintenance  and  service,  and  this  may  be  enforced  and 
secured  even  to  the  exclusion  of  dividends.  Take  a  case  of  a 
corporation  which  has  issued  only  stock  and  has  no  bonds  or 
nuMtgage  indebtedness  outstanding — as  is  not  unusual  in  New 
England  j)articularly — in  such  a  case  the  entire  investment  of  the 
stockholders  is  a  guarantee  of  good  service.  Why  then  should  a 
Pul^lic  Utility  Commission  insist  that  the  public  be  further 
guaranteed  by  additional  security  in  the  form  of  a  depreciation 
reserve  fund. 

It  has  l)een  argued  that  without  a  reserve  fund  a  public  utility 
owner  is  tempted  to  let  his  plant  depreciate  and  to  withdraw 


DEPRECIATION  301 

from  the  property  the  funds  necessary  for  its  maintenance,  but 
this  is  an  abnormal  and  unusual  condition.  The  valuations  of  a 
large  number  of  utility  properties  of  all  kinds,  made  in  all  parts 
of  the  country  by  a  host  of  independent  and  separate  appraisers, 
result  in  showing  that  the  average  condition  of  utility  properties 
in  this  country  is  usually  Ijetween  80  per  cent,  and  90  per  cent, 
of  reproduction  value  new  after  deducting  the  amount  of  theo- 
retically estimated  and  accruing  depreciation.  Consequently, 
it  may  be  stated  without  fear  of  contradiction  that  the  con- 
dition of  the  average  utility  plant  is  not  run-down  or  giving 
inferior  service,  whether  or  not  reserve  funds  have  been  main- 
tained. If  then  the  physical  property  of  a  utility  plant  is  in  a 
condition  to  render  proper  service,  it  is  rendering  it  or  not, 
depending  upon  the  wishes  of  the  corporation  officials  and  the 
public  authorities,  but  in  either  case  the  value  of  the  property 
is  the  same.  Similarly,  if  the  property  is  in  condition  to  render 
proper  service,  its  value  is  the  same,  whether  a  guarantee  of 
maintenance  is  secured  in  one  instance  by  deposit  of  reserve 
funds,  or,  in  the  second  instance,  by  the  entire  investment  of 
the  stockholders  and  bondholders.  Who  shall  say  that,  because 
a  given  utility  has  not  accumulated  a  cash  reserve  fund  before 
public  regulation  was  instituted,  therefore  the  newly  created 
Commission  now  has  the  right  to  deprive  the  corporation  of  a 
part  of  the  value  of  its  property?  The  value  of  utility  property 
being  determined  and  allowed  by  a  Public  Service  Commission  is 
admittedly  not  such  value  as  would  obtain  from  the  sale  of  the 
several  parts  of  the  plant  for  use  elsewhere,  but  rather  that 
particular  value  due  to  the  location,  suitableness  and  ability  of 
the  parts  of  the  plant,  used  together,  to  render  the  service 
required  in  the  community  considered.  If  then  the  value  of  the 
property  is  fixed  by  its  value  for  service  and  not  by  its  exchange 
value,  the  full  100  per  cent,  value  must  be  allowed  when  the 
plant  is  rendering  100  per  cent,  service  and  not  some  proportion 
of  the  full  value,  simply  because  some  time  in  the  future,  in 
order  to  maintain  the  quality  of  the  service,  the  different  phys- 
ical elements  must  be  replaced,  which  contingency  is  being 
normally  provided  for  in  the  charges  made  for  services  being 
rendered. 

It  is  immaterial  to  the  consumer  whether  the  apparatus  is 
new,  in  "middle  life"  or  "aged,"  provided  the  quality  of  the 
service  is  maintained.     There  is  no  reason  why  the  consumer 


302  VALUE  FOR  RATE-MAKING 

should  expect  a  lower  rate  in  the  fifth  year  of  the  life  of  a  plant, 
simply  because  some  of  its  items  at  that  time  will  require  renewal 
five  years  earlier  in  the  future,  than  at  the  date  of  beginning 
operation.  The  charge  against  the  consumer,  included  in  the 
rate,  on  account  of  depreciation,  must  be  maintained  throughout 
the  entire  life  of  the  plant,  in  order  to  provide  earnings  suf- 
ficient to  permit  its  renewal.  If  the  depreciated  present  value  of 
the  propert}^  were  taken  as  a  basis  of  fixing  rates,  when  the  worn 
out  parts  are  renewed,  the  investment  must  thereby  of  necessity 
be  increased,  and  as  renewals  cannot  properly  be  charged  to 
capital  account,  the  owner  being  compelled  to  maintain  his 
property,  will  not  be  earning  a  fair  return  on  the  amount  of 
difference  between  the  depreciated  value  allowed,  and  the  cost 
new  of  the  renewal.  Even  if  the  excess  cost  of  the  renewal 
items,  above  the  depreciated  value  originally  allowed,  should  be 
charged  to  capital  account,  as  a  practical  matter  it  would  be 
almost  impossible  to  increase  rates  to  meet  the  requirements  of 
the  increased  fair  return. 

Investments  in  public  utilities  are  made,  not  with  the  expecta- 
tion that  capital  is  to  be  paid  back  to  the  investor  in  relatively 
small  amounts  annually,  or  that  it  is  invested  for  a  relatively 
few  years.  Capital  invested  in  utilities  must  necessarily  be  tied 
up  for  a  long  period  of  time.  As  a  matter  of  fact,  it  is  not 
possible  for  utility  owners  to  sell  their  properties  frequently,  or 
easily,  except  at  a  great  sacrifice  of  investment.  In  ordinary 
commercial  enterprises,  the  investment  in  plant  is  small  relative 
to  the  value  of  the  annual  sales,  with  the  result  that  the  capital 
invested  is  turned  over  from  one  to  five  times  a  year,  in  case 
the  owner  so  desires;  with  the  public  utility,  however,  the  case 
is  quite  different,  when  once  started  the  utility  must  be  con- 
tinued, or  the  loss  of  practically  the  whole  or  greater  part  of 
the  investment  will  result,  even  though  the  venture  may  prove 
a  steadily  losing  one. 

The  investor  in  a  pubhc  utility  nmst  do  often  without  his 
interest  at  the  start  and  even  provide  additional  amounts  of 
capital  for  additions  and  extensions  in  order  to  i)rotect  tlic; 
original  investment  with  the  hope  of  ultimately  putting  the 
whole  on  a  paying  basis. 

Calculations. — As  the  calculation  of  "present  value"  on  a 
sinking  fund  basis  is  a  somewhat  complicated  process,  the  table 
on   the  following  page  is  presented  as  a  matter  of  convenience. 


DEPRECIATION 


m.i 


Tablk  XII.— Depreciation  Table  Calculated  on  a  4  per  cent.  Sink- 
ing Fund  Basis 


Assumet 

Life 

5 

6 

8 

10 

12 

14 

15 

16 

18 

20 

25 

30 

40 

50 

75 

100 

Age 

82 

85 
69 
53 
36 
18 

89 
78 
66 
54 
41 

92 
83 
74 
65 
55 

93 

86 
79 
72 
64 

95 

89 
83 
77 
70 

95 
90 

84 
79 
73 

95 
91 
86 
81 
75 

96 
92 
88 
83 
79 

97 
93 
90 
86 
82 

98 
95 
93 
90 
87 

98 
96 
94 
92 
90 

99 
98 
97 
96 
94 

99 
99 
98 
97 
96 

1 

62 

2 

42 

3 

22 

4 

99.0 

5 

28 

45 

56 

64 

67 

70 

74 

78 

84 

88 

93 

96 

98.7 

6 

14 

34 

47 

57 

61 

64 

69 

73 

81 

86 

92 

95 

98.3 

7 

23 

39 

50 

54 

58 

64 

69 

78 

84 

90 

94 

98.1 

8 

12 

30 

42 

47 

52 

59 

64 

75 

81 

89 

93 

97.9 

9 

20 

34 

40 

45 

53 

60 

71 

79 

87 

92 

97.5 

99.6 

10 

10 

26 

33 

38 

47 

55 

68 

76 

86 

91 

97.1 

99.5 

11 

' 

18 

25 

31 

41 

50 

64 

73 

84 

90 

96.8 

99.4 

12 

9 

17 

24 

35 

44 

60 

70 

83 

89 

96.3 

99.2 

1.} 

9 

16 

29 

39 

56 

67 

81 

88 

96.0 

99.1 

14 

8 

22 

33 

52 

64 

79 

87 

95.7 

89.0 

15 

15 

27 

48 

61 

77 

86 

95.2 

98.9 

16 

8 

20 

14 

7 

43 
38 
34 

28 

23 

18 

12 

6 

58 
54 
51 
47 

43 
39 
35 
30 
26 

21 

16 

11 

6 

75 
73 
71 
69 

66 
64 
61 
59 
56 

53 
50 
47 
44 
41 

38 
34 
30 
26 
22 

18 

14 

10 

5 

84 
83 
82 
80 

79 
78 
76 
74 
73 

71 
69 
67 
65 
63 

61 
59 
57 
54 
52 

49 
46 
44 
41 
38 

35 
31 
28 
24 
21 

17 
13 
9 

4 

94.8 
94.2 
93.9 
93.4 

92.9 
92.2 
91.8 
91.0 
90.4 

89.9 
89.2 
88.5 
87.9 
87.0 

86.2 
85.6 
84.9 
84.0 
83.1 

82.4 
81.5 
80.5 
79.6 
78.6 

77.5 
76.5 
75.4 
74.1 
73.0 

71.6 
70.0 
68.8 
67.1 
65.8 

98.8 
98.6 
98.4 
98.1 

98.0 
97.9 
97.8 
97.5 
97.2 

97.0 
96.8 
96.5 
96.1 
96.0 

95.7 
95.3 
95.0 
94.8 
94.2 

94.0 
93.6 
93.2 
92.9 
92.4 

92.0 
91.5 
91.0 
90.5 
90.0 

89.5 
89.0 
88.4 
87.9 
87.2 

17 
18 
19 
20 

21 
22 
23 
24 
25 

26 
27 
28 
29 
30 

31 
32 
33 
34 
35 

36 
37 
38 
39 
40 

41 
42 
43 
44 
45 

46 
47 
48 
49 
50 

304  VALUE  FOR  RATE-MAKING 

The  "present  value,"  that  is,  the  remaining  vahie  of  propertj'^, 
computed  on  a  4  per  cent,  sinking  fund  basis,  may  be  obtained 
at  any  age  given  in  the  column  to  the  extreme  right  of  the  table, 
by  multiplj'ing  the  cost  new  of  the  property  by  the  appropriate 
percentage  given  in  the  life  column  for  the  life  assumed.  If 
the  property  is  assumed  to  have  any  scrap  or  salvage  value  at 
the  expiration  of  its  life,  the  amount  of  same  must  be  first  de- 
ducted from  the  cost  new  before  applying  the  percentage  from 
the  table,  as  above,  and  then  that  same  amount  must  be  added 
to  the  product  obtained,  in  order  to  secure  the  present  value 
including  scrap  or  salvage. 

In  making  estimates  of  the  amount  of  depreciation  existing  in 
a  given  utility  property  considered  as  a  whole,  the  nature  of  each 
of  the  elements  subject  to  deterioration  that  make  up  that  prop- 
erty must  be  separately  considered.  Some  of  these  elements  are 
worn  out  in  a  few  years,  others  in  10,  20  or  even  100  or  200  years, 
depending  on  the  material  of  which  the  element  is  constructed, 
the  care  it  has  received,  method  of  operation  and  effect  of  climate 
and  other  local  conditions.  The  first  step  in  determining  the 
depreciated  condition  of  the  entire  property  is  to  group  the  sev- 
eral elements  or  classes  of  property  in  accordance  with  their 
several  distinctive  life  characteristics,  then  to  determine  the  age 
of  each  historically,  namely,  by  an  examination  of  records  and 
dates  of  installation;  next  to  adopt  estimates  of  the  assumed  life 
properly  attributable  to  the  several  elements,  and  on  the  basis  of 
these  assumptions  the  depreciated  condition  of  each  group  is 
computed;  the  values  thus  arrived  at  are  modified  by  estimates  of 
the  actual  physical  condition  of  the  property  as  determined  from 
inspection  of  competent  engineers.  As  the  final  step,  the  de- 
preciated condition  of  the  property  as  a  whole,  that  is,  the 
"composite"  remaining  life  value,  is  determined  by  either  one  of 
two  methods: 

(a)  The  Dollar  Year. 

(b)  The  Direct  Method. 

In  order  to  determine  "composite  life"  by  either  method,  the 
property  is  all  classified  as  to  cost  new,  as  well  as  scrap  value, 
from  which  is  determined  the  amount  in  dollars,  of  each  class  of 
property  subject  to  depreciation.  In  acicordance  with  the  dollar 
year  method  and  the  estimated  lives  allotted  to  each  class  of 
property : 


DEPRECIA  TION 


305 


"There  is  then  determined  the  totul  number  of  dollars  required  for 
each  class  during  the  longest  life  period,  and  this  in  turn  is  multiplied  by 
the  number  of  years  during  which  each  dollar  does  duty.  The  result  of 
this  multiplication  is  a  figure  representing  dollar  years,  which  is  divided 
between  the  total  dollars  used  for  the  purpose  of  replacement  during  the 
longest  life  period,  which  gives  the  average  or  composite  life."^ 

In  order  to  determine  the  composite  life  of  the  plant  by  the 
direct  method,  the  dollars  value  subject  to  depreciation,  of  each 
class  of  property,  is  multiplied  by  the  annual  rate  of  depreciation 
and  the  sum  of  the  products  divided  into  the  sum  of  the  (!Ost  new  of 
all  the  classes  of  property.  These  two  methods  have  been  worked 
out  and  are  shown  in  detail  in  the  accompanying  Tables  XIII, 
XIV  and  XV. 


Table  XIII. — "Dollar  Year"  Method 


Class 

Life 

Cost  of 
reproduc- 
tion new 

Scrap 
value 

Cost 
new 
less 
scrap 

Times  re- 
newed in 
75-year 
period 

Dollars 

required 

in  75-year 

period 

Dollar 
years 

A 

5 

$210 

$0 

$210 

15.00 

$3,150 

15,750 

B 

8 

7,124 

14 

7,110 

9.38 

66,692 

533,536 

C 

10 

17,361 

153 

17,208 

7.50 

129,060 

1,290,600 

D 

12 

26,272 

0 

26,272 

6.25 

164,200 

1,970,400 

E 

15 

143,470 

11,920 

131,550 

5.00 

657,750 

9,866,250 

F 

16 

65,632 

33,375 

32,258 

4.69 

151,290 

2,420,640 

G 

20 

113,336 

9,239 

104,097 

3.75 

390,364 

7,807,280 

H 

25 

43,747 

7,631 

36,116 

3.00 

108,348 

2,708,700 

I 

50 
60 

14,337 
1,165 

0 
0 

14,337 
1,165 

1.50 
1.25 

21,506 
1,456 

1,075,300 

J 

87,360 

K 

75 

21,920 

0 

21,920 

1.00 

21,920 

1,644,000 

Total 

$454,574 
12  per  cent. 

$62,331 
overhead 

$392,243 
47,069 

$1,715,736 

29,419,816 

$439,312 

,.,    29,419,861  „  ,^ 

Average  life    i  yi  c  yog    =  17.15  years. 

"These  methods  are  of  the  greatest  importance  in  this  connection  and 
will  therefore  be  more  fully  explained.  In  order  to  illustrate  the  results 
obtained  in  actual  practice  under  each  one  of  these  methods,  they  have 
been  applied  to  the  depreciable  property  of  the  electric  lighting  and  power 
plant,  the  composite  life  of  which  is  shown  in  Tables  XIII  and  XIV. 
The  electric  plant  was  selected  for  this  purpose  because  its  life  is  short 
and  the  calculations  therefore  comparatively  few.  The  tables  show,  among 
other  things,  the  amounts  that  must  be  set  aside  annually  from  earnings 

1  City  of  Ripon  vs.  Ripon  Light  &  Water  Co.,  5  W.  R.  C.  R.  20. 
20 


306 


VALUE  FOR  RATE-MAKING 


Table  XIV. — Direct  Method 
Straight  Line 


Class 


Life 


Cost  of 

reproduction 

new 


Scrap 
value 


Cost 

new  less 

scrap 


Annual 
per  cent,  of 
deprecia- 
tion 


Annual 
amt. required 
to  cover  de- 
preciation 


A 

5 

B 

8 

C 

10 

D 

12 

E 

15 

F     

16 

G       

20 

H 

25 

I 

50 

J 

00 

K             

75 

Total 

$210 

7,124 

17,361 

26.272 

143.470 

65.632 
113.336 
43.747 
14.337 
1.165 
21.920 


$0 

14 

153 

0 

11.920 

33.374 

9.239 

7.631 

0 

0 

0 


$210 

7.110 

17.208 

26,272 

131,550 

32,258 
104,097 
34,116 
14,337 
1.105 
21.920 


$454,574  $62,331 

12  per  cent,  overhead. 


$392,243 
47.069 


$439,312 


20.00 

12.50 

10.00 

8 .  33 

0.07 

6.25 
5.00 
4.00 
2.00 
1.67 
1.33 


$42 

889 
1,721 
2,188 
8,774 

2,016 
5,205 
1,445 

287 
19 

292 


$22,878 
2,745 


25,623 


,.,     392,243        ,,,^ 
Average  life    ^o  aya  ^  1'15  years. 


Table  XV. — Direct  Method 
4  Per  Cent.  Sinking  Fund 


Class 

Life 

Cost  of 

reproduction 

new 

Scrap 
value 

Cost 

new  less 

scrap 

.\nnual   per 

cent,  re- 
served on  4 
per  cent, 
basis 

-Annual 
fund 

A 

B 

C 

D 

5 

8 

10 

12 

15 

16 
20 
25 
50 
60 
75 

$210 

7,124 

17,361 

26,272 

143,470 

65.632 
113..3.30 
43.747 
14.337 
1.105 
21,920 

$0 

14 

153 

0 

11,920 

.33,374 

9,239 

7,031 

0 

0 

0 

$210 

7,110 

17.208 

20,272 

131,550 

32,258 
104,097 
.30,110 
14,337 
1,105 
21,920 

18.46 

10.85 

8.33 

6.65 

4.99 

4.58 
3.36 
2.40 
0.65 
0.42 
0.22 

$39 

771 

1,4.33 

1  747 

E 

F 

G 

6,564 

1,478 
3.498 

H 

867 

I 

93 

J 

5 

K 

48 

Total 

$454,574 

«ri9  .•^.•<i 

$392,243 
47.069 

$16,543 

12  per  cent,  overhead.  .  . 

1,985 

$439,312 

$18,528 

Average  life 


10,543 
392.243 


0.04217   -    17.01  years. 


DEPRECIATION  :W7 

under  eacli  of  these  methods  to  cover  the  depreciation  charges.  They 
show  this  for  the  property  in  each  life  group  as  well  as  for  all  the  groups  or 
the  plant  as  a  whole.  It  will  be  noticed  that  the  so-called  overhead 
charges  in  construction  were  excluded  from  the  costs  upon  which  the 
depreciation  charges  were  figured.  This  was  done  more  as  a  matter 
of  convenience  in  the  calculations  than  because  some  at  least  of  these 
overhead  costs  are  not  proper  items  to  be  covered  by  depreciation  allow- 
ances. The  formula  used  in  the  calculation  in  each  case  is  also  given  in 
the  respective  tables.  In  order  to  shed  further  light  on  these  methods 
and  enable  some  conclusion  to  be  drawn  as  to  their  respective  ad- 
vantages or  disadvantages,  tables  have  also  been  worked  out  and  included 
herein  which  show  for  each  method,  for  the  period  given,  the  respective 
amounts  placed  in  the  depreciation  reserve  to  cover  depreciation,  and 
withdrawn  therefrom  to  cover  the  cost  of  renewing  discarded  property, 
together  with  the  cumulative  balances  on  hand  in  the  reserve.  In  these 
calculations  it  has  been  assumed  that  each  part  of  the  plant  is  to  be 
renewed  at  the  end  of  its  estimated  life,  and  that  the  life  of  the  plant 
is  therefore  perpetual.  It  has  further  been  assumed  that  the  amount  set 
aside  from  year  to  year  remains  the  same,  and  that  there  are  no  changes 
in  the  cost  of  the  property  during  the  period.  The  computations  in  the 
tables  cover  a  period  of  75  years,  which  period  corresponds  to  the  life 
of  that  group  of  the  property  which  has  the  longest  life.  This  period 
was  chosen  in  order  to  show  the  condition  of  the  reserve  account  up  to 
the  time  when  all  the  property  had  been  renewed  at  least  once.  Before 
these  methods  are  further  explained  and  illustrated  it  should  be  pointed 
out  that  the  cost  new  of  the  depreciable  property  of  the  electric  plant  in 
question  amounts  to  $454,574;  that  the  scrap  value  of  the  same  foots  up 
to  $62,331;  and  that  the  balance  between  this  cost  and  scrap  value  is 
$392,243.  This  balance  represents  the  total  depreciation,  or  the  cost  of 
renewals  that  must  be  provided  for  during  the  composite  life  of  the  plant 
in  order  to  keep  the  investment  intact.  As  this  composite  life  of  the 
plant  as  a  whole  is  about  17.15  years,  the  average  amount  per  year  is 
about  $22,878.  It  should  also  be  explained  that  with  an  annual  require- 
ment for  depreciation  of  $22,878,  the  total  requirements  for  75  years 
would  amount  to  $1,715,850.  Under  the  straight  line  method,  the 
amount  that  should  be  set  aside  annually  to  cover  depreciation  is  ob- 
tained by  dividing  the  balance  between  the  cost  new  of  the  property 
and  its  scrap  value  by  its  estimated  life.  As  in  this  case  this  balance, 
as  stated,  was  $392,243,  and  the  composite  life  of  the  plant  17.15  years, 
the  annual  amount  to  be  set  aside  for  depreciation  is  $22,878.  These 
facts  are  illustrated  in  Table  XIV.  This  table  also  shows  that  the  annual 
rate  of  depreciation  varies  from  20  per  cent,  for  the  property  in  the  5- 
year  group  to  1.33  per  cent,  for  the  property  in  the  75-year  group. 
The  average  rate  for  all  of  these  groups  is  5.83  per  cent,  on  the  depreciable 
amount.     The  straight  line  method  is  much  more  simple  and  direct 


308  VALUE  FOR  RATE-MAKING 

than  any  of  the  other  methods.  It  is  advocated  by  the  interstate  com- 
merce commission  and  for  certain  purposes  also  by  the  Wisconsin  and 
other  State  commissions.  Under  the  sinking  fund  method  it  is  assumed 
that  the  amounts  set  aside  for  depreciation  are  invested  or  used  at  com- 
pound interest,  and  that  the  interest  so  obtained  also  goes  into  the  de- 
preciation reserve.  Since  in  this  case  the  interest  on  the  sum  thus  set 
aside,  as  well  as  these  sums  themselves,  becomes  a  part  of  the  fund,  it 
necessarily'  follows  that  the  latter  need  not  be  as  large  as  would  be  the 
case  if  no  interest  was  allowed  thereon.  On  a  4  per  cent,  sinking  fund 
basis,  the  amount  so  set  aside  and  charged  to  expenses  is  S16,543,  or 
about  4.20  per  cent,  on  the  property.  When  the  interest  on  balances 
from  this  time  on  also  is  included,  it  is  found  that  the  amounts  placed  in 
the  fund  gradually  increase.  At  4  per  cent,  compound  interest,  the 
annual  allowances  increase  from  $16,543  for  the  first  year,  to  S23,545 
for  the  tenth  and  $30,985  for  the  seventeenth  year.  When  both  the 
principal  and  the  interest  allowances  are  thus  considered,  the  total 
amounts  thus  set  aside  for  depreciation  will  be  found  to  be  considerably 
higher  than  when  the  former  alone  is  considered.  It  is  seen  from  these 
figures  that  under  this  method  the  estimated  depreciation,  or  the  pro- 
visions therefor,  are  lowest  at  first  and  are  then  gradually  increasing 
from  year  to  year.  This  is  also,  as  a  rule,  the  course  that  is  followed  by 
the  earnings  of  public  utilities.  It  is  further  held  that  it  is  in  accord  with 
the  course  of  actual  depreciation  from  the  point  of  view  of  the  service 
value  of  the  property.  As  a  part  of  the  provisions  for  depreciation  is 
made  up  of  interest  allowances  on  the  balances  in  the  depreciation  fund, 
it  also  follows  that,  under  this  method,  the  direct  charges  to  operating 
expenses  for  this  purpose  are  correspondingly  lower.  These  facts  tend 
to  place  this  method  in  rather  favorable  light.  It  is  also  used  by  the 
Wisconsin  commission,  when  it  seems  to  be  the  method  that  is  best 
suited  to  the  conditions."' 

From  these  tables  it  will  be  seen  that,  while  the  rate  of  depre- 
ciation per  year,  on  a  straight  line  basis,  varies  from  20  per  cent, 
for  the  property  having  the  shortest  life  to  1.33  per  cent,  for  the 
property  having  the  longest  life,  the  average  rate  of  depreciation 
is  5.83  per  cent,  on  the  composite  life  of  17.15  years.  In  a 
similar  way  the  annual  rate  of  depreciation  on  a  4  per  cent,  sink- 
ing fund  basis  will  be  found  to  be  about  4.20  per  cent,  for  the 
composite  life. 

Attention  may  be  called  to  the  difference  in  the  average  or 
composite  life  derived  by  the  sinking  fund  method,  which  is 
17.05  years  as  compared  with  17.15  years,  derived  by  the  dollar 

'  Paper,  "Depreciation,"  by  Hon.  Halford  Erickson,  Convention  of  Central  Water-worke 
AwociatioD,  Detroit,  Mich.,  Sept.  25,  1912. 


DEPRECIATION  300 

year  and  direct  methods.  It  might  seem  at  first  glance  as  if  the 
difference  was  due  to  some  error  in  computation.  Such  is  not  the 
case,  however,  as  will  be  seen  from  the  following  explanation. 
In  the  dollar  year  and  direct  methods  the  average  life  is  the  num- 
ber of  years  that  will  elapse  before  the  property  will  have  depre- 
ciated an  amount  equal  to  the  first  cost  less  scrap  value,  that  is,  a 
number  of  years  must  elapse  in  order  that  the  accumulation  of 
payments  made  to  cover  depreciation  will  amount  to  the  first 
cost.  In  the  use  of  the  sinking  fund  method,  the  average  or  com- 
posite life  is  the  number  of  years  required  to  accumulate  an 
amount  equal  to  the  first  cost  of  the  plant,  less  scrap  value,  at  a 
certain  annuity,  provided  no  withdrawals  from  the  accumulated 
fund  are  anticipated.  The  method  used  is  based  upon  the  with- 
drawals from  time  to  time  from  the  fund  accumulated  by  the 
payments  of  the  annuity,  with  its  interest  accruals,  as  becomes 
necessary  to  renew  the  worn-out  parts.  To  meet  these  demands 
made  from  time  to  time  upon  the  fund,  in  accordance  with  the 
assumptions,  there  must  always  be  available  in  the  fund 
amounts  sufficient  to  meet  the  depreciation  requirements.  This 
difference  in  principle  and  method  has  been  clearly  explained 
by  Dr.  Alexander  C.  Humphreys  as  follows: 

"By  the  direct  scheme  (no  interest)  the  accumulation  of  annual  pay- 
ments in  the  fund  must  necessarily  be  equal  at  the  end  of  any  year  to  the 
accrued  depreciation.  By  the  compoimd  interest  scheme  this  necessarily 
would  never  be  the  case  unless  a  time  was  reached  when  all  the  parts  of 
plant  expired  at  the  same  time.  There  is  always  an  overlapping  of  the 
life  periods  of  the  several  parts  of  plant,  and  so  there  will  never  be  in  the 
fund  sufficient  to  meet  the  total  depreciation,  though  there  will  alwaj's 
be  enough  to  meet  the  requirements  as  to  each  part  of  the  plant  as  it  has 
to  be  renewed.  This  means  that  when  this  overlapping  of  hfe  periods 
occurs,  as  it  probably  always  would  in  practice,  the  compound  interest 
sinking  fund  scheme,  strictly  speaking,  is  only  applicable  to  the  case  of  a 
plant  operating  in  perpetuity.  It  is  thus  seen  that  the  compound  inter- 
est sinking  fund  scheme,  and  the  simpler  scheme,  which  eliminates 
interest  accumulations,  are  essentially  different  in  operation.  In  con- 
nection with  the  sinking  fund  scheme  the  term  'average  life'  is  mislead- 
ing, whereas,  by  the  direct  scheme  the  true  average  life,  if  desired,  can 
be  determined  by  the  method  shown  in  this  supplementary  note. 

"To  further  illustrate  that  the  true  average  life  will  not  be  the  same  as 
the  time  during  which  a  sinking  fund  scheme,  if  undisturbed,  will  accu- 
mulate the  total  value  of  plant,  we  may  apply  a  2  per  cent,  and  a  6  per 
cent,  sinking  fund  scheme  to  the  hfe  table  already  used.     To  make  the 


310 


VALUE  FOR  RATE-MAKIXG 


comparison  more  apparent,  I  will  include  in  the  one  table  these  two 
schemes,  the  original  4  per  cent,  scheme  and  the  direct  scheme  which 
entirely  eliminates  interest : 

Table  XVI 


Parts  of 
plant 

Esti- 
mated life 
in  years 

Value  of 
plant  in 
dollars 

Amount  to  be  set  aside  eaoh  year  to 
cover  depreciation 

G  per  cent. 

sinking 

fund 

4  per  cent. 

sinking 

fund 

2  per  cent. 

sinking 

fund 

0  per  cent, 
no 

interest 

A 

10 

25.000 

1,896.75 

2.082.25 

2,283.25 

2.500.00 

B 

15 

50,000 

2,148.00      2,497.00 

2.891.50 

3,333.33 

C 

25 

100,000 

1,823.00      2,401.00 

3,122.00 

4,000.00 

D 

35 

150,000 

1.345.50 

2,037.00 

3,000.00 

4,285.71 

E 

50 

175,000 

Total  annual 

602.00 

1,146.25 

2.068.50 

3,500.00 

Total  value  of  plant   .  .  ,500,000 

7,815.25    10,163.50 

1.3,.305.25 

17,0 19. 04 

payments 

Annual  payments  in  per  cent,  of 

plant  value 

1.563 

2.03 

2.673 

3.524 

Years  required  to  redeem  total 

value  of 

27.05 

27.73 

28.2 

28  378 

"It  is  thus  seen  that  as  the  interest  rate  of  the  sinking  fund  increases 
not  only  will  the  annual  depreciation  payment  be  reduced  in  amount,  but, 
if  we  stipulate  that  in  the  meantime  no  withdrawals  shall  l)e  made  as  in 
fact  called  for  by  the  life  table,  then  the  time  required  to  accumulate  the 
total  value  of  plant  will  also  be  reduced. 

"This  seeming  contradiction  is  the  result  of  this  stipulation,  necessarily 
introduced  for  this  time  comparison.  For  we  must  remember  that  the 
amounts  actually  withdrawn  to  meet  partial  depreciations  ('A,'  'B,' 
'C,'  'D,'  and  'E'),  in  accord  with  the  life  table,  will  be  the  same,  no 
matter  what  the  sinking  fund  rate  of  interest;  and  as  we  assume  that 
these  amounts  are  to  be  left  in  the  fund  and  allowed  to  accumulate,  the 
higher  the  rate  of  sinking  fund  interest  the  greater  will  be  the  tendency 
of  these  accumulations  to  reduce  the  time  in  which  the  total  value  (jf 
plant  will  be  produced. 

"The  higher  the  sinking  fund  rate  of  interest,  the  smaller  will  be  the 
sinking  fund  liability  for  each  part  between  the  several  withdrawal 
dates,  therefore,  the  .slower  the  accumulation  and  a  consequent  tendency 
between  withdrawal  dates  to  lengthen  the  so-called  average  life.  While 
this  tendency  ceases  for  each  part  at  its  withdrawal  date,  the  tendency 
is  always  in  force  with  some  of  the  parts,  and  therefore  always  affects 
the  scheme  as  a  whole."' 


'  Suppleriifnt  No.  1  to  I.octure  Notes  by  Dr.  Alex.  C.  Humphreys. 


INDEX 


Absolute  and  theoretical  deprecia- 
tion, 239 
Accruing  depreciation  not  allowed, 

245 
Act  to  regulate  commerce,  12 
Adams  Express  Co.  vs.  Ohio,  193 
Address  delivered  before  American 

Elec.   Railway  Ass'n  at  Atlantic 

City,  70 
Agency  theory,  50 
American  Society  of  Civil  Engineers, 

committee  report  on  water,  140 
American    Telegraph    &    Telephone 

Com.,  Maryland  P.  S.  C,  139 
Ames  vs.  Union  Pacific  Railway  Co., 

131 
Annual  depreciation  rates.  Table  X, 

255-256 
Antioch  decision,  29,  51,  260,  295 
Appellate  Court  of  California,  246 
Appleton  Water  Works  Co.  vs.  City 

of  Appleton,  138 
Appleton     Water     Works    Co.    vs. 

Railroad  Com.  of  Wisconsin,  206 
Arnold,  B.  J.,  280 
Average      return     on      depreciated 

value,  Table  XI,  262 


Black  Feet  Indians,  in  Conrad 
Investment  Co.  vs.  U.  S.,  144 

Blood,  W.  H.,  testimony  before 
P.  S.  C.  of  Missouri,  100,  203 

Blue  Hill  Street  Railway  Co.,  de- 
cision of  Mass.  P.  S.  C,  263 

Board  of  Gas  &  Electric  Light  Com., 
Mass.,  87 

Board  of  Utility  Commissioners  of 
New  Jersey,  Passaic  case,  129,  160 

Bonbright,  Wm.  P.  et  al.  vs.  W.  P. 
Greary  et  al.,  196 

Bond  discount,  172 

Bowers,  Herbert  O.,  vs.  Conn.  Co., 
Docket  No.  8,  278 

Brief,  Hon.  Geo.  S.  Coleman,  189, 
228,  230 

Brief  filed  in  behalf  of  the  railroad 
companies  represented  by  the 
President's  Conference  Com.  be- 
fore the  Interstate  Com.,  Sept.  1, 
1915,  53,  104 

Brief  of  E.  F.  Jones  and  B.  W. 
Couch,  185 

Broder  vs.  Water  Co.,  142 

Bronx  Gas  &  Electric  Co.  case,  128 

Brooklyn  Gas  Co.  case,  128 

Brunswick  &  Topshaw  Water  Dist. 
vs.  Maine  Water  Co.,  64 


B 


Basis  for  rates,  1 

Basis  of  value,  66 

Bassett,    Edward    M.,    member    of 

N.  Y.  P.  S.  C,  1st  Dist.,  in  address, 

43,  83 
Beatty,  Judge,  247 
Before  and  after  regulation  begins, 

27 
Bingham  and  Garfield  Railroad  case, 

45 


Calculations,  302 

California  R.  R.  Com.,  Palo  Alto  Gas 

Co.  case,  288 
Cataract  Power  &  Conduit  Co.  (see 

Fuhrman). 
Cedar  Rapids  Gas  Co.  case,  230 
Cedar    Rapids    Gas    Light    Co.  vs. 

Cedar  Rapids,  181,  193,  199 
Chapter  I.   Introduction,  1 
Chapter  II.  Definitions,  21 


311 


312 


INDEX 


Chaptor  III.  Fundamentals  in  Valua- 
tion, 27 
Chapter   IV.   Fair   \'alue   for   Rate- 
making,  54 
Chapter   V.  Cost  of   Reproduction, 

100 
Chapter     VI.  Land,     Paving     and 

Water  Rights,  132 
Chapter  VII.  Franchises,  Working 

Capital  and  Bond  Discounts,  157 
Chapter  VIII.  Going  Value,  177 
Chapter  IX.  Depreciation,  235 
Chicago,  etc.,  R.  R.  vs.  Dey,  81 
Chicago,     Milwaukee    &    St.    Paul 

R.  R.  vs.  Minnesota,  9 
City  of  Beloit  vs.  Beloit  Water,  Gas 

&  Electric  Co.,  153 
City  of  Chicago  contracts,  124 
City  of  Danville  et  al.  vs.  Southern 

Railway,  123 
City    of    Greenbay    vs.    Greenl^aj' 

Water  Co.,  220 
City  of  Helena  vs.  The  Helena  Light 

&  Railway  Co.  P.  S.  C.  of  Mont., 

27G 
City    of     Knoxvillc    vs.    Knoxvillc 

Water  Co.,  101,  193,  267,  269 
City   of    Milwaukee  vs.    Milwaukee 

Gas  Light  Co.,  126,  225,  279 
City  of  Omaha  vs.  Omaha  Water  Co., 

242 
City  of  Plainfield,  New  Jersey,  case, 

49 
City   of   Ripon  vs.    Ripon  Light  & 

Water  Co.,  305 
City  of  Whitewater  vs.  Whitewater 

P.  L.  Co.,  277 
City    of    Worcester    vs.    Worcester 

Con.  Street  Railway  Co.,  4,  49 
Classes  of  depreciation,  25 
Cleveland,    Cincinnati,    Chicago   it 

St.  Louis  Ry.  vs.  Backus,  11,  65, 

192 
Coal    and    Coke    Railway    Co.    vs. 

Conley,  10 
Coleman,    Hon.    Geo.  S.,    brief    for 

P.  S.  C.  of  N.  Y.,  189,  228,  230 
Columbus  Railway  &  Light  Co.  vs. 

City  of  Columbus,  Circuit  Court 


U.  S.  Southern  Dist.  of  Ohio, 
report  of  Master,  242 

Commission  Decisions  (see  De- 
cisions of  Commissions). 

Commissioner  Prouty  of  Interstate 
Commerce  Com.,  Spokane  vs. 
Northern  Pacific  Ry.,  73 

Comparison  depreciation  condition, 
Table  IX,  253 

Comparison  of  earnings,  Table  I,  98 

Competition,  34 

Conrad  Investing  Co.  vs.  United 
States,  143,  144 

Consolidated  Gas  Co.  case,  depre- 
ciation, 78 

Consolidated  Gas  Co.  case,  pres- 
sure, 76 

Consolidated  Gas  Co.  vs.  Mayer,  70 

Consolidated  Gas  Co.  vs.  New  York, 
11,  52,  103 

Consolidated  Gas  Co.  vs.  Wilcox,  71 

Construction  schedule,  113 

Contra   Costa   Water  Co.,    196 

Contractor's  profit,  117 

Cost  of  reproduction,  100 

Cost  of  reproduction  defined  by 
P.  U.  Commissioners,  105 

Cost  to  reproduce  new,  23 

Cotting-vs.  Kansas  City  Stock 
Yards,  71 

Couch,  B.  W.,  185 

Court  decisions,  76 

Court  decisions: 

Adams  Express  Co.  of  Ohio,  193 
Ames  vs.  Union  Pac.  Ry.  Co.,  131 
Appleton   Water  Works   Co.    vs. 

City  of  Appleton,  138 
Bonbright,  Wm.  P.  et  al.  vs.  Wm. 

Greary  el  al.,  196 
Broder  vs.  Water  Co.,  142 
Brunswick     &     Topshaw     Water 

Dist.  vs.  Maine  Water  Co.,  64 
Cedar  Rapids  Gas  Light  Co.  vs. 

Cedar  Rapids,  181,  193,  199 
Chicago,  etc.,  R.  R.  vs.  Dey,  81 
Chicago,    Milwaukee  &   St.   Paul 

R.  R.  vs.  Minnesota,  9 
City  of  Danville  et  al.  vs.  Southern 
Railway,  123 


INDEX 


313 


Court  Decisions. — Continued. 
City   of   Knoxville  vs.  Knoxville 

Water  Co.,  101,  193,  230,  267, 

269 
City  of  Omaha  vs.  Omaha  Water 

Co.,  242 
City  of  Worcester  vs.  Worcester 

Con.  St.  Rwy.  Co.,  4,  49 
Cleveland,  Cincinnati,  Chicago  & 

St.  Louis  Ry.  vs.  Backus,  11,  65, 

192 
Coal  &  Coke  Rwy.  Co.  vs.  Conley, 

10 
Columbus  Railway  &  Light  Co.  vs. 

City  of    Columbus,    report  of 

Master,  242 
Conrad  Investing  Co.  vs.  United 

States,  143,  144 
Consolidated   Gas  Co.  of  N.  Y., 

Master's  Report,  78,  79 
Consolidated  Gas  Co.  vs.  Mayer, 

70 
Consolidated  Gas  Co.  vs.  City  of 

New  York,  11,  52,  71,  103 
Cotting   vs.    Kansas    City  Stock 

Yards,  71 
Covington  &  Lexington  Turnpike 

Road  Co.  vs.  Sanford,  8 
Cumberland  Tel.  &  Telg.  Co.  vs. 

City  of  Louisville,  71,  294 
Des  Moines  Gas  Co.  vs.  City  of 

Des  Moines  et  al,  136,  196,  199, 

208 
Des  Moines  Water  Co.  vs.  City  of 

Des  Moines,  72,  104,  188,  195, 

204 
Emery  vs.  Wilson,  248 
Fall  River  Gas  Co.  vs.  Board  of 

Gas  &  Elec.  Light  Com.,  75 
German  Alliance  Ins.  Co.  vs.  Ike 

Lewis,  Supt.  of  Insurance  of  the 

State  of  Kansas,  7 
Gibson  vs.  Chouteau,  144 
Hamilton    Gas    Co.,    Ltd.,  vs. 

Hamilton  Corp.  App.,  213 
Jennisson  vs.  Kirk,  142 
Kansas  vs.  Colorado,  142 
Kennebec  Water  Dist.  vs.  City  of 

Waterville  et  al.,  28,  87,  158,  179 


Court  Decisions. — Continued. 
Kings    County   Lighting   Co.   vs. 

Wilcox  et  al,  P.  S.  C,  46,  180, 

189,  197,  208,  209,  212,  231,  233 
Kings  County  Lighting  Co.  case, 

133,  196 
Knoxville  (see  City  of  Knoxville). 
Light  vs.  United  States,  143 
Louisville  &  Nashville  R.  R.  vs. 

Railroad    Commission    of    Ala- 
bama, 135 
Louisville  &  Nashville  R.  R.  vs. 

Railroad  Commission,  71,  103 
Macintosh  et  al.  vs.  Flint  &  Pierre 

Marq.  R.  R.  et  al,  248 
Manhattan  Railway  Co.  vs.  W^ood- 

bury,  294 
Matthews    vs.    Board    of    Corp. 

Commissioners,  70 
Metropolitan  Trust  Co.  vs.  Hous- 
ton &  T.  C.  R.,  194 
Miller  &  Lux  vs.  Madero  Canal  & 

Irrigation  Co.,  147 
Milwaukee  Elec.  Railway  &  Light 

Co.  vs.  City  of  Milwaukee,  131 
Minnesota  rate  cases,  11,  37,  65, 

71,  76,  84,  101,  103,  271 
Missouri   K.    &    T.    Ry.    Co.   vs. 

Love,  195 
Monongahela  Navigation  Co.  vs. 

U.  S.,  159 
Munn  vs.  Illinois,  7,  8 
Murray  vs.  Public  Utilities  Com., 

102,  265 
National  Tel.  Co.,  Ltd.  vs.  H.  M. 

Postmaster,  124 
National    Water-works     Co.    vs. 

Kansas  City,  69,  192 
Norwich  Gas  &  Electric  Co.  vs. 

City  of  Norwich,  212 
Oshkosh     Water-works     Co.    vs. 

Railroad  of  Wise,  227 
Palmer  et  al.  vs.  Railroad  Commis- 
sion of  the  State  of  California,  146 
Perth  Gas   Co.,  .Ltd.  vs.   City  of 

Perth  Corp.  App.,  214 
Pioneer   Telephone   &   Telegraph 

Co.  vs.  Westenhaver,  121,  179, 

192,  196,  204,  206 


314 


INDEX 


Court  Decisions. — Continued. 
Pollard  el  al.  vs.  John  Hagan  et  al., 

141 
Public    Service    Electric    Co.    v.s. 

Board  of  Utility  Coimnissioncrs 

of  N.  J.,  50 
Public  Service  Gas  Co.  vs.  Board 

of  Public   Utility  Commission- 
ers    of    N.    J.,    84,    161,    162, 

179 
Reagan     vs.     Farmers     Loan     & 

Trust  Co.,  9,  47,  215 
Redlands     Liigonia     &     Grafton 

Domestic    Water  Co.  vs.   City 

of  Redlands,  247 
San  Diego  Land  &  Town  Co.  vs. 

National  City,  11,  64,  70,  80 
San  Diego  Land  &  Town  Co.  vs. 

Jasper,  11 
San    Diego    Water    Co.   vs.    San 

Diego,  51,  186,  247 
San  Joaquin  &  Kings  Co.    River 

Canal  &  Irrigation  Co.  vs.  City 

of  Stanislaus  et  al.,  155 
Shepard  vs.  Northern  Pacific  Ry., 

11,  84,  103 
Simpson  vs.  Shepard,  71 
Smyth  vs.  Ames,  10,  65 
Spring    Valley    Water-works    vs. 

City  of  San  Francisco,  11,  81, 

159,  187,  196 
St.  Louis  &  San  Francisco  Rail- 
way vs.  Gill,  10 
Tutt  vs.  Land,  248  ^ 
United    States   vs.    Kansas   Pac. 

Ry.  Co.,  248 
United  States  vs.  Utah  Power  & 

Light  Co.,  144 
Venner    vs.    Urbana    Water    Co., 

179,  194 
Washington  Reports,  89 
Wilcox  et  al.  vs.  Consolidated  Gas 

Co.  (see  also  Consolidated  Gas 

Co.),  52,  65,  71,  133,  158 
Winter  vs.  United  States,  143 
Court  of  Appeals,  State  of  N.  Y., 
The  People  ex  rel.  Kings  Co. 
Lighting    Co.    vs.    Wilcox    et    al., 

P.  S.  C,  1st  Dist.,  231,  233 


Covington    &    Lexington    Turnpike 

Road  Co.  vs.  Sanford,  8 
Crowell,  Chief  Engineer  P.  S.  C.  of 

N.  Y.,  2d  Dist.,  279 
Cumberland    Tel.    &   Telg.    Co.    vs. 

City  of  Louisville,  71,  294 
Curve,  New  Orleans  Water  Works, 

222 
Curves  of  depreciation.  Fig.  1,  240 


D 


Decision  of  Railroad  Commission  of 
California  No.  1110  in  the  matter 
of  the  application  of  North  Coast 
Water  Co.,  etc.,  51 

Decision  of  P.  S.  C.  of  Idaho  in  re 
application  of  Pocatello  Water 
Co.,  148 

Decision  of  Interstate  Com.,  Spokane 
vs.  Northern  Pacific  Railway,  33 

Decision  of  Mass.  P.  S.  C.  approving 
an  increase  in  the  rates  of  fare  of 
the  Middlesex  &  Boston  Railway 
Co.,  107 

Decision  of  P.  S.  C.  of  State  of  Mis- 
souri, June  23,  1914,  McGregoi- 
Noe  Hardware  Co.  el  al.  vs.  Spring- 
field Gas  &  Electric  Co.,  etc., 
229 

Decision  of  P.  S.  C.  of  New  York, 
2d  Dist.,  18 

Decision  of  P.  S.  C.  of  New  York, 
2d  Dist.  in  re  Fuhrman  vs. 
Cataract  Power  &  Conduit  Co., 
3,  148,  164,  189 

Decision  of  Railroad  Com.  of  Cali- 
fornia, Town  of  Antioch  vs. 
Pacific  Gas  &  Elec.  Co.,  30,  260, 
295 

Decisions  of  commissions: 

Board  of  Gas  &  Electric  Lt.  Com- 
missioners of  Massachusetts: 
Report,  1913,  88 
Board  of  Public  Utility  Commis- 
sioners of  New  Jersey: 
City  of  Plainfield,  49 
Gately  &  Hurley  cl  al.  vs.  Del. 
&  Atl.  T.  &  T.  Co.,  275 


INDEX 


315 


Decisions    of    Commissions. — 
Continued. 
Public  Service  Gas  Co.,  Passaic 
District,  129,  160,  203,  274 
Interstate  Commerce  Commission : 
Chesapeake  &  Ohio  R.  R.  Co.,  42 
Opinion  No.  1830,  40 
Report  No.  180G,  56 
Spokane    &     Northern     Pacific 

Railway  Co.,  33,  73 
Union  Tanning  Co.  vs.  Southern 
Railway  Co.,  87 
Public     Service     Commission     of 
Idaho: 
In  re  application  of  Pocatello 
Water  Co.,  148 
Public     Service     Commission     of 
Maryland : 
A.  T.  &  T.  Co.,  139 
Public     Service     Commission     of 
Massachusetts : 
Blue  Hill  Street  Railway   Co., 

263 
Middlesex    and    Boston    Rwy. 
Co.,  19,  107,  263 
Public     Service     Commission     of 
Missouri : 
McGregor-Noe    Hardware    Co. 
et  al.  vs.   Springfield   Gas  & 
Elec.  Co.,  229 
Public     Service     Commission     of 
New  Hampshire: 
Grafton  El.  Lt.  &  P.  Co.,  154 
Manchester  St.  Rwy.  Co.,  207 
Public     Service     Commission     of 
New  York: 
First  District: 

Bronx  Gas  &  Electric  Co.,  128 
Mayhew  vs.  Kings  Co.  Light- 
ing Co.,  229 
Queensboro  Gas  &  Elec.  Co., 

83,  127,  128,  284 
Stadtlander  vs.  N.  Y.  Edison 
Co.,  19 
Second  District: 

Fuhrman  vs.  Cataract  Power 
&  Conduit  Co.,  3,  106,  148, 
164,  189,  257,  266,  271,  276, 
296 


Decisions    of    Commissions. — 
Continued. 
Public     Service     Commission     of 

Washington: 
Pacific  N.  W.  Traction  Co.,  134 
P.  S.  C.  of  Washington  vs.  Paget 

Sound  Elec.  Rwy.  Co.,  89 
Seattle,    Renton    &    So.    Rwv. 

Co.,  257 
Public     Utilities    Commission    of 

Connecticut: 
Bowers  et  al.  vs.  Conn.  Co.,  278 
Railroad     Commission     of     Cali- 
fornia : 
Antioch  vs.  Pacific  Gas  &  Elec. 

Co.,  29,  30,  51,  260,  295 
Central  Calif.  Gas  Co.,  32,  124 
Eureka  Water  Co.,  154 
North  Coast  Water  Co.,  51 
Northern  Calif.  Power  Co.,  154 
Pala  Alto  Gas  Co.,  288 
San  Jose  vs.  San  Jose  Water  Co., 

227 
San    Rafael    &    San    Anselmo 

Valley  Railway  Co.,  124 
Wells  Fargo  Express  Co.,  95 
Railroad  Commission  of  Montana : 
City  of  Helena  vs.  The  Helena 

St.  &  Rwy.  Co.,  276 
Railroad  Conmiission  of  Nevada: 
Ely  Lt.  &  P.  Co.,  276 
P.  S.  C.  of  Nev.  vs.  Nev.  &  Cal. 

P.  Co.,  150,  160 
Railroad  Commission  of  Oregon: 

Home  Tel.  &  Telg.  Co.,  52 
Railroad  Commission  of  Wiscon- 
sin: 
City  of  Beloit  vs.  Beloit  W.  G. 

&  El.  Co.,  153 
Fuller  vs.  Wausau  St.  Rwy.  Co., 

242,  277 
Greenbay  vs.   Greenbay  Water 

Co.,  220 
Hill  vs.   Antigo,  163,  173,  206, 

242,  277,  278,  293 
Milwaukee    vs.    Milwaukee    G. 

Lt.  Co.,  126,  225,  279 
Milwaukee  El.  Rwy.  &  Lt.  Co., 

298 


316 


INDEX 


Decisions    of    Commissions, — 

Cotitinued. 

Milwaukee  Lt.,  Ht.  &  Tr.  Co.,  90 
Neenah  vs.  Wise.  Tr.,  Lt.,  Ht. 

&  P.  Co.,  159 
Oshkosh  Water  Works  Co.,  138, 

227 
Rhinlander  P.  Co.,  153 
Ripon  vs.  Ripon  Lt.  &  Wt.  Co., 

305 
Ross  et  al.  vs.  Burkhardt  Mill. 

&  Elec.  Co.,  152 
State  Jour.  Ptg.  Co.  vs.  Madi- 
son Gas  &  Elec.  Co.,  88,  89, 
279 
Superior  Com.   Club  et  al.  vs. 

Duluth  St.  Rwy.  Co.,  297 
Whitewater  vs.  Whitewater  P. 
&  Lt.  Co.,  277 
State     Railway     Commission     of 
Nebraska : 
Sixth  Annual  Report,  266 
St.  Louis  Public  Service  Commis- 
sion: 
Southwestern  Telg.  &  Tel.  Co., 

273 
Union  El.  Lt.  &  P.  Co.,  131,  273 
United  Railways  Cos.,  273 
Decisions  of  Courts  (see  Court 

Decisions). 
Decision  of  Washington  Public  Serv- 
ice Com.,  Pacific  N.  W.  T.  Co.,  134 
Decision     of     Wisconsin     Railroad 
Com.,    Milwaukee   Electric    Rail- 
way &  Light  Co.,  298 
Decision  of  the   Railroad  Com.   of 
Wisconsin  in  re  application  of  the 
Rhinlander  Power  Co.,  153 
Definitions,  21 
Delaware  and  Atlanta  Tel.  iV  Tolji. 

Co.,  275 
Denver  &  Rio  Grande  Railroad  case, 

45 
Depreciation,  24 
Depreciation  basis,  259 
Depreciation  curves.  Fig.  3,  251 
Depreciation  curves,  Fig.  4,  252 
Depreciation   and   appreciation,   bj' 
W.  H.  Forse,  Jr.,  256 


Depreciation  estimates  by  Edwin 
Gruhl,  A.  E.  R.  A.,  March,  1913, 254 

Depreciation  and  estimates  inac- 
curate, 249 

Depreciation  funds,  291 

Depreciation,  New  York  court  pre- 
fers straight  line,  293 

Depreciation  paper  by  Commis- 
sioner Erickson,  308 

Depreciation,  Wisconsin  Com.  uses 
straight  line  and  sinking  fund, 
292 

Des  Moines  Gas  Co.  vs.  City  of  Des 
Moines  et  al.,  130,  178,  188,  196, 
199,  208 

Des  Moines  Water  Co.  vs.  City  of 
Des  Moines,  72,  104,  188,  195,' 204 

Development  costs,  120 

Development  expenses  or  overhead 
charges,  23 

Development  of  law,  7 

Development  of  theory,  100 

Direct  method  sinking  fund.  Table 
XV,  300 

Direct  method,  straight  line.  Table 
XIV,  300 

Dollar  year  method.  Table  XIII,  305 


E 


Eaton,  J.  S.,  236 

Efficiency  in  operation  and  utili- 
zations, 84 

Ely  Light  &  Power  Co.  of  Nevada, 
270 

Engineering,  architect's  fees,  etc.,  117 

Engineering-Contracting,  93,  150,  205 

Erickson,  Commissioner  R.  R.  Com. 
of  Wisconsin,  278,  308 

Eshleman,  Ex-Conmiissionerof  Cali- 
fornia Commission,  29 

Eureka  Water  Co.  of  California,  154 

Expenses  of  operation,  90 

Explanatory,  21 


Fair  rate,  80 

Fair  value  basis,  67 


INDEX 


317 


Fair  value  for  rate-making,  54 

Fall  River  Gas  Co.  case,  74 

Fall  River  Gas  Works  Co.  vs.  Hoard 

of  Gas  &  Elec.  Light  Com.,  75 
Federal  valuation,  11 
Figure    1.  Curves    of    depreciation, 

240 
Figure  2.  Straight  line  and  .sinking 

fund  curves,  Gruhl,  250 
Figure     3.       Depreciation     curves, 

pumps,  Gruhl,  251 
Figure  4.   Depreciation   curves,  hu- 
man mortality,  Gruhl,  252 
Financial  costs,  124 
Fluctuating  prices,  116 
Forse,  W.  H.,  Jr.,  256 
Foster,   "Engineering  Valuation    of 

Public  Utilities  and  Factories,"  101 
Franchises,  157 
Franchises,     working     capital     and 

bond  discounts,  157 
Free  service,  48 
Fuller  vs.  Wausau  St.  Railroad  Co., 

R.  R.  Com.  of  Wisconsin,  242,  277 
Fundamentals  in  valuation,  27 
Fuhrman,  Mayor  vs.  Cataract  Power 

&  Conduit  Co.  (see  under  Decision 

of  Commissions),  3,  160,  271 


G 


Going  value  not  plant  operation,  22S 
Going  value  not  rate  of  return,  231 
Going  value  in  rate  cases,  185 
Going  value  relationa,  Table  VI,  219 
Good-will,  24 
Grants,  47,  158 
Gruhl,  Edwin,  254 


H 


Hamilton  Gas  Co.,  Ltd.  vs.  Hamil- 
ton Corp.  App.,  213 

Handbook  of  railroad  expenses,  J.  S. 
Eaton,  236 

Hearings  on  rates  of  the  P.  S.  Gas 
Co.,  203 

Hill  et  al.  vs.  Antigo  Water  Co.,  163, 
173,  206,  227,  228,  277,  293 

Hill  et  al.  vs.  Antigo  Railroad  Com. 
of  Wisconsin,  242 

Home  Telegraph  &  Telephone  Co. 
case,  52 

How,  Jared,  Esq.,  Proceedings  of 
the  American  Society  of  Civil 
Eng.,  283 

Howard,  C.  P.,  132 

Humphreys,  Dr.  Alex.  C,  280,  309 

Hutchings,  J.  T. ,  Gen.  Mgr.  Roches- 
ter Railway  &  Light  Co.,  99 


Garroutte,  Judge,  246 

Gas  and  Electric  Light  Commis- 
sioners of  Mass.,  73 

Gas  pressure,  76 

General  discussion,  235 

German  Alliance  Ins.  Co.  vs.  Ike 
Lewis,  Supt.  of  Ins.  of  the  State 
of  Kansas,  7 

Gibson  vs.  Chouteau,  144 

Gifts  and  donations,  46 

Gillette,  H.  P.,  Discussion  on  Phys- 
ical Valuation  of  Railroads,  etc.,  .59 

Going  value,  24,  177 

Going  value,  four  meanings,  200 
First:  expenses,  200 
Second:  deficiency,  204 
Third:  income,  212 
Fourth:  comparison,  216 


Illustrations,  281 

Individual  opinion,  278 

In  the  matter  of  gas  and  electric 

rates  charged  by  Queensboro  Gas 

&  Electric  Co.,  etc.,  83^ 
Insurance,  119 
Instruction  to  appraisers,  56 
Interest,  120 
Interest  and  reward,  90 
Interstate  Commerce  Act,  12 
Interstate    Commerce    Commission, 

Report    No.  1806,  railroad  rates, 

56 
Interstate    Commerce    Commission. 

in   Spokane  vs.    Northern  Pacific 

Rwy.,  73 


318 


IXDEX 


Interstate    Commerce    Commission, 

29th  Annual  Report,  18 
Inventory,  113 
Investment  not  value,  61 


Jennisson  vs.  Kirk,  142 
Jones,  E.  F.,  185 


K 


Kansas  City  Water-works  case,  215 
Kansas  vs.  Colorado,  142 
Kennebec     Water    Dist.,     City    of 

Waterville  et  al.,  28,  57,  87,  158, 

179 
Kings   Co.   Lighting    Co.   case    (see 

under  Court  decisions),  128,  133, 

197 
Knoxville    Water-works    case    (see 

under  Court  decisions),  230,  267 


Land,  paving  and  water  rights,  132 

Land  values,  132 

Law  and  method,  60 

Leake,  P.  D.,  291,  296 

Lecture  Notes  on  Business  En- 
gineering, by  A.  C.  Humphreys, 
2d  Ed.,  1912,  281 

Light  vs.  United  States,  143 

Louisville  &  Nashville  R.  R.  vs. 
Railroad  Com.  of  Alabama,  196 
Fed.  821,  135 

Louisville  &  Nashville  R.  R.  vs. 
Railroad  Com.,  71,  103 


M 


McCarter,  T.  M.,  April  13,  1914,  3 
Mcintosh   et  al.  vs.    Flint  &  Pierre 

Marq.  R.   R.  el  al.,  248 
Maltbie,  Ex-Commissioner,  291 
Marks,  Wm.  D.,  78 
Maryland  State  Commission,  138 
Master's  Report,  Consolidated  Gas 

Co.  of  N.  Y.,  79 


Mathewson,  Chas.  F.,  210 
Matthews  vs.  Board  of  Corp  Com., 

70 
Mayhew  vs.  Kings  County  Lighting 

Co.  (see  under  Court  decisions), 

133,  229 
Menominee  &   Marionette  Light  & 

Traction  Co.,  279 
Metcalf,  L.,  in  the  Transactions  of 

the    American    Society    of    Civil 

Eng.,  201 
Metropolitan  Trust  Co.  vs.  Houston 

&  T.  C.  R.,  194 
Middlesex  &  Boston  Railway  Co.,  19 
Miller  &  Lux  vs.   Madera  Canal  & 

Irrigation  Co.,  147 
Miller,    Judge    of    N.    Y.    Court   of 

Appeals—People  ex  rel.  Kings  Co. 

Lighting  Co.  vs.  Wilcox  et  al.,  46 
Milwaukee  Electric  Railway  &  Light 

vs.  City  of  Milwaukee,  131 
Milwaukee  going  value,  Table  VIII, 

225 
Minnesota  rate  cases  (see  also  Court 

decisions),ll,  37,65,76,84, 101,271 
Missouri  K.  &  T.  Ry.  Co.  vs.  Love, 

195 
Monongahela    Navigation    Co.    vs. 

U.  S.,  159 
Munn  vs.  Illinois,  7,  8 
Murray  vs.    Public    Utilities  Com., 

102,  265 


N 


National  Association  of  Railroad 
Commissioners,  43 

National  Tel.  Co.,  Ltd.,  vs.  H.  M. 
Postmaster,  124 

National  Water-works  Co.,  230 

National  Water-works  Co.  vs.  Kan- 
sas City,  69,  192 

Neenah  vs.  Wisconsin  Traction, 
Light,  Heat  &  Power  Co.,  159 

New  York  Edison  Co.,  18 

New  York,  New  Haven  &  Hartford 
Railroad  Co.,  279 

New  York  Sun,  Dec.  14,  1912,  122 

North  Coast  Water  Co.,  Calif.,  51 


INDEX 


319 


Northern  California  Power  Co.  case, 

154 
Norwich    Gas   &    Electric    Co.    vs. 

City  of  Norwich,  212 


O 


Obsolescence,  26 

Omaha  vs.  Omaha  Water  Co.,  ISO 
230 

Omissions,  incidentals  and  contin- 
gencies, 118 

Opinion  No.  1830  in  the  Matter  of 
the  Investigation  of  Alleged  Un- 
reasonable Rates  Involved  in  the 
Transportation  of  Wool,  Hides, 
etc.,  40 

Opinion  and  decision  of  Railroad 
Com.  of  Wisconsin  vs.  Milwaukee 
Light,  Heat  &  Traction  Co.,  96 

Oregon  &  California  Railroad  land 
grant,  47 

Original  cost,  22 

Oshkosh  Water-works  Co.  vs. 
Railroad  Com.  of  Wisconsin,  138, 
227 

Other  bases,  18 

Overhead  charges,  125 


Palo  Alto  Gas  Co.  decision,  Railroad 
Com.  of  California,  288 

Palmer  et  al.  vs.  Railroad  Commis- 
sion of  the  State  of  Cal.  et  al.,  146 

Paper  "Depreciation,"  by  Hon.  H. 
Frickson,  Convention  of  Central 
Water-works  Ass'n,  308 

Passaic  gas  case  (see  also  Public 
Service  Gas  Co.),  129 

Paving,  135 

People  ex  rel.  Kings  Co.  Light- 
ing Co.  vs.  Wilcox  et  al.,  composing 
P.S.  C,  1st  Dist.,  46,  133,  180, 
189,  196,  208,  209,  212 

People  ex  rel.  Manhattan  Railway 
Co.  vs.  Woodbury,  294 

Perth  Gas  Co.,  Ltd.  vs.  City  of 
Perth  Corp.,  214 


Petition  of  Grafton  Electric  Light 
&  Power  Co.,  decided  Feb.  3, 
1914,  by  New  Hampshire  P.  S.  C, 
154 

Physical  or  structural  value,  21 

Pioneer  Tel.  &  Telg.  Co.  vs.  Westen- 
haver,  121,  179,  192,  196,  204,  206 

Pollard,  John,  et  al.  vs.  John  Ilagen 
et  al.,  141 

Preface,  v 

Preliminary  expenses,  122 

Present  value,  22,  70 

Principles  involved,  54 

Principles  of  Valuation,  by  R.  H. 
Whitten,  231 

Privy  Council  of  Eng.,  going  value, 
213 

Proceedings  of  the  American  Water- 
works Ass'n,  Table  VII,  224 

Proceedings  of  the  23d  Annual 
Convention,Nat.Ass.  Ry.  Com.,  43 

Promotion,  123 

Prouty,  35-37 

Public  Service  Commission  of  Mass., 
19,  263 

Public  Service  Commission  of  Ne- 
vada vs.  Nevada  &  Cal.  Power  Co., 
150,  160 

Public  Service  Commission  of  New 
York,  1st  Dist.,  accounts,  122 

Public  Service  Commission  of  New 
York,  2d  Dist.,  106,  164,  257, 
266,  271,  276,  278 

Public  Service  Commission  of  Wash- 
ington vs.  Puget  Soimd  Elec. 
Railway  cases,  89 

Public  Service  Electric  Co.  vs. 
Board  of  Utility  Commissioners 
of  N.  J.,  50 

Public  Service  Gas  Co.  case,  129, 
160,  203,  274 

Public  Service  Gas  Co.  overheads, 
Table  IV,  129 

Public  Service  Gas  Co.  vs.  Board 
of  P.  U.  Com.,  84,  160,  162,  179 

Public  Utilities  Act  of  California, 
295 

Public  utiHty  decisions,  273 

Purpose  affects  valuation,  42 


320 


INDEX 


Q 


Queens  Borough  case,  127,  128 

Queens  Borough  case,  overheads, 
Table  II,  127 

Queens  Borough,  Kings  County, 
Brooklyn  Gas,  overheads.  Table 
III,  lis 

Queens  Borough,  in  re  Gas  &  Elec- 
tric Co.,  83,  127,  128,  284 


Report  of  Railroad  Commission  of 

California,  29,  30,  32,  51,  95,  124, 

154,  227,  2(>0,  288,  295 
Report  of  Railroad  Securities  Com., 

123 
Reproduction  new,  109 
Reserve  funds,  285 
Right  of  regulation,  4 
Ross  et  al.  vs.  Burkhardt  Milling  & 

Elect,  Power  Co.,  152 


R 


S 


Railroad  Commission  of  California, 
29,  30,  32,  51,  95,  124,  154,  227, 
260,  288,  295 

Railroad  Commission  of  Oregon  in 
re  Home  Tel.  &  Telg.  Co.,  52 

Railroad  Company's  brief  before 
Interstate  Commerce  Com.,  53, 
104 

Railroad  Securities  Commission, 
promoter's  profit,  123 

Reagan  vs.  Farmers  Loan  &  Trust 
Co.,  9,  47,  215 

Redlands,  Lugonia  &  Grafton  Do- 
mestic Water  Co.  vs.  City  of  Red- 
lands  el  al.,  247 

Report  of  Gas  &  Electric  Light 
Commissioners  of  Mass.,  88 

Report  and  Decision  of  the  Rail- 
road Commission  of  Cal.,  Thomas 
Monohan  as  Mayor  of  the  City  of 
San  Jose  vs.  San  Jose  Water  Co., 
227 

Report  and  Order  of  Board  of  P.  U. 
C.  in  the  matter  of  Gately  &  Hur- 
ley el  al.  vs.  Del.  &  Atl.  Tel.  &  Telg. 
Co.,  275 

Report  and  Order  of  the  Interstate 
Commerce  Commission  in  the 
matter  of  investigation  and  sus- 
pension of  advances  in  rates  for 
the  transportation  of  coal  by  the 
Chesapeake  &  Ohio  Railroad  Co., 
etc.,  42 

Report  of  the  Public  Service  Com- 
mission, State  of  New  Hampshire, 
207 


San    Diego   Land   &   Town    Co.  vs. 

Jasper,  11 
San  Diego  Land    &   Town   Co.  vs. 

National  City,  11,  64,  70,  80 
San  Diego  Water  Co.  vs.  San  Diego, 

51,  186,  247 
San    Joaquin    &    Kings    Co.    River 

Canal  &  Irrigation  Co.  vs.  City  of 

Stanislaus  el  al.,  155 
San  Rafael  &  San  Anselmo  Valley 

R.  R.  Co.,  124 
Scrap  or  salvage  value,  22 
Seattle,  Renton  and  Southern  Rail- 
way Co.  rate  case,  257 
Senate  Committee,  39 
Service  value,  22 
Shepard  vs.    Northern   Pacific   Ry., 

11,  84,  103 
Simpson  vs.  Shepard,  71 
Sixth  Anrmal  Report  of  the  Nebraska 

State   Railway  Com.  to  the  Gov- 
ernor, 266 
Smyth  vs.  Ames,  10,  65 
Some  legal  aspects  of  regulation  of 

P.  S.  Corp.,  211 
Southern  Pacific  Railway,  87 
Southern  Pacific  Railway  grant,  158 
Southwestern  Telg.  &  Tel.  Co.,  273 
Spring      Valley      Water-works     vs. 

City  of  San  Francisco,  11,  81,  159, 

187,  196 
Statlander   in  re   vs.   N.   Y.  Edison 

Co.,  19 
State    Journal     Printing     Co.     vs. 

Madison  Gas  &  Electric  Co.,  88, 

89,  279 


INDEX 


321 


St.  Louis  Public  Service  Commis- 
sion, 131,  273 

St.  Louis  &  San  Francisco  Railway 
Co.  vs.  Gill,  10 

Stevens,  F.  W.,  address,  G9,  100 

Straight  line  and  sinking  fund 
curve,  Fig.  2,  250 

Summarized  elements  of  reproduc- 
tion cost,  112 

Superior  Commercial  Club  el  al.  vs. 
Duluth  Street  Railway  Co.,  2«)7 

Superseded  plant,  130 

Supplement  No.  1  to  Lecture  Notes 
by  A.  C.  Humphreys,  310 

Supreme  Court  of  Iowa,  181,  187 

Supreme  Court  of  New  Jersey,  161 

Supreme  Court  of  United  States, 
4,  7,  8,  9,  10,  11,  47,  49,  64,  65, 
69,  71,  76,  81,  101,  131,  136,  142, 
143,  144,  156,  158,  159,  180,  183, 
190,  192,  193,  195,  199,  208,  215, 
230,  242,  248,  267,  269,  271 

Swain,  Prof.  Geo.  F.,  279 


Table  I.  Comparison  of  earnings,  98 

Table  II.  Queens  Borough  case,  over- 
heads, 127 

Table  III.  Queens  Borough,  Kings 
Co.,  Brooklyn  Gas,  overheads,  128 

Table  IV.  Public  Service  Gas  Co., 
overheads,  129 

Table  V.  Working  capital,  171 

Table  VI.  Going  value  relations,  219 

Table  VII.  Years  to  acquire  one 
dollar,  224 

Table  VIII.  Milwaukee  going  value, 
225 

Table  IX.  Comparison  depreciation 
condition,  253 

Table  X.  Annual  depreciation  rates, 
255,  256 

Table  XI.  Average  return  on  de- 
preciation value,  262 

Table  XII.  Depreciation  Table  Cal- 
culated on  4  Per  Cent.  Sinking 
Fund  Basis,  303 

Table  XIII.  Dollar  year  method,  305 


Table  XIV.   Direct  method,  straight 

line,  306 
Table  XV.  Direct  nictlKxi,  sinking 

fund,  306 
Table  XVI.  Sinking  fund    rate  und 

life,  310 
Taxes,  122 
Testimony  of  Hon.  Milo  R.  Malt})io 

before  Ohio  P.  S.  C.  in  re  liucyus 

Light  &  Power  Co.,  292 
Thelan,    Coinmi.ssioner  of   Railroad 

Commission  of  California,  259,  295 
Town  of  Antioch  vs.  Pacific  Gas  & 

Electric  Co.,  29,  30,  51,  260,  295 
Trustee  theory,  53 


U 


Uniform  system  of  accounts,  P.  S.  C. 

of  N.  Y.,  1st  Dist.,  122 
Union  Electric  Light  &  Power  Co. 

of  St.  Louis,  131,  273 
Union    Tanning   Co.    vs.    Southern 

Railway  Co.,  87 
United  Railways  Co.  of  St.  Louis, 

273 
United  States  vs.  Kansas  Pac.  Ry. 

Co.,  248 
United    States   vs.    Utah    Power  & 

Light  Co.,  144 
Unit  prices,  114 
Use  and  Misuse  of  Sinking  Fund,  by 

P.  D.  Leake,  291,  296 


Value,  21 

Value  in  appraisals,  68 

Value  of  service,  86 

Value  not  fixed  by  depreciation 
fund,  297 

Valuation  Act  of  Congress,  12 

Valuation  of  Public  Service  Corp.,  82 

Valuation  of  Public  Utilities,  by 
R.  H.  Whitten,  101 

Valuation  of  Public  Utility  Proper- 
ties, by  Henry  Hoy,  173,  218,  237 

Valuation  of  Railroads,  by  Hon.  C.  A. 
Prouty,  35,  37 

Van  Fleet,  Justice,  51 


322 


INDEX 


Venner  vs.  Urbana  Water  Co.,  179, 
194 

W 

Washington  Laws,  1911.  214 

Washington  Reports,  89 

Water  law,  A.  S.  C.  E.,  140 

Water  rights,  139 

Wearing  value,  22 

Wells    Fargo    Express    Co.     rates, 

California,  94 
Westchester  Lighting  Co.,  279 
Whitten,  R.  II.,  S2,  101,  231 


Whitney,  Asa,  going  value,  205 
Wilcox  et  at.  vs.  ConsoHdated  Cas 

Co.,  65,  71,  133,  158 
Wilson,  President  Woodrow,  3 
Winter  vs.  United  .States,  143 
Working  capital,  165 
Working  capital.  Table  V,  171 


Years  to  acquire  one  dollar,  Table 
VII,  224 


i^t{  1     li^3ii^^<^: 


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